Opinion: Bank Runs are an Unnecessary Evil
This article is guest authored by Chen-Chen Huo, from Nexus. The content does not necessarily reflect opinions from Yumi Money.
By now, you have probably heard of the bank run on Silicon Valley Bank (SVB), which eventually ended in the bank’s insolvency.
What had happened is that SVB used their customer’s deposits to make investments, which unfortunately turned a loss of $1.8 billion. When SVB reported that loss, customers got scared and started pulling out their money. By March 9th, SVB’s customers had withdrawn a total of $42 billion. This caused the bank to run out of cash, leaving it with a negative cash balance of approximately $958 million, at which point the bank was insolvent, and the regulators took control over the bank [1].
So was this a case of rampant fraud? Was SVB allowed to invest their customers' deposits in risky assets, promising that those deposits would never fall in value, and are always fully accessible? As it turns out, SVB’s behavior is completely legal, and it’s called fractional reserve banking. With fractional reserve banking, a bank only needs to keep a small amount of their deposits in cash, and is free to use the rest to make illiquid and somewhat risky investments.
And SVB is not the only bank that has made significant losses on their investments lately. Unrealized losses of the banking sector skyrocketed to a total of $620 billion in the fourth quarter of 2022. These losses are mostly caused by the FEDs increase in interest rates, and the resulting decline in the value of long term loans issued at the previously lower rates [2].
Some people believe that fractional reserve banking is a necessary evil. You get your occasional bank run, and government bailout, but that’s the price you have to pay for having bank accounts with instant access to cash, and somewhat decent returns on the money. But that’s just not true, banking doesn’t have to be sketchy.
For example, at Nexus, we offer our customers all the same features that they are used to from a traditional bank account --- debit cards, paycheck deposits, ATMs, checks, etc --- but our customers always have full custody and control over their deposits; Nexus simply holds on to their assets. When all our customers decide to withdraw all their assets on the same day, we just give it to them, and that’s that.
To get good returns, our customers can choose how they want to invest their deposits. They are in full control. For example, they can invest in short term U.S. treasuries, i.e. loans to the government that are protected by the full faith and credit of the U.S. government, and have a pretty decent current yield of 4.54% [3]; or they can invest in a broadly diversified stock market fund, which has more ups and downs, but provided an average annual return of 8.09% [4] since its inception 21 years ago. Since deposits don’t need protection from bad investments made by the bank, funds are not FDIC insured. They are however SIPC insured, to protect in the case that Nexus acts like a bad custodian and steals customer assets.
All the investment vehicles offered by Nexus are highly liquid, so when our customers want to withdraw money, we simply sell their assets on the markets. When the markets are closed, e.g. on the weekend, we provide our customers with a free short term cash advance, and then sell their assets when the markets open up again. With this setup, there is no incentive for a bank run, because customers always have custody over their deposits, and even with larger than usual withdrawals, the markets adjust prices to establish liquidity.
In summary, fractional banking, bank runs, and government bailouts are not a necessary evil. We can give people full control and custody over their deposits, together with instant access to cash, and better returns than they would get in their normal bank account.
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Chen-Chen is one of the co-founders of Nexus, a banking and investing product that earns market returns for people, not institutions. Chen-Chen is a self-admitted Boglehead, travel enthusiast, and will talk your butt off about interest rates and investment vehicles if you give him the opportunity. All views are his own and for educational purposes only.
