We live in very special times, from many points of view. Essentially any aspect of our life is being disrupted and this wave of unusuality is impacting banks as well: banks are seeing their deposits going up, they are getting a lot of money, but, for once, that isn’t necessarily a good thing.
The usual way: bank runs
Usually people put their money in banks confident that they are safely stored, easily accessible and ideally producing some sort of returns. In the large majority of cases, things go well.
Unfortunately, sometimes they don’t: banks can collapse. Every time that a bank is even rumored to be in bad waters, a large number of depositors immediately ran out and queue up outside bank branches hoping to withdraw their money and secure them before a possible collapse.
This run to the branches would then cause even more troubles to the bank, ultimately resulting in the actual collapse of the institution.
This phenomenon is defined as a bank run, and it has been a fairly common occurrence in banking history. Wikipedia provides a very interesting page with the list of the most significant bank runs.
The covid-way: reverse bank runs
In 2020, after Covid-19 hit, things are going differently. Many banks are today suffering from the exact opposite problem: they have too much cash and are reluctant to accept more deposits.
Today depositors are keeping their money in bank accounts. This is due to various reasons: less opportunity to spend money, a desire to save for uncertain times, but also the lack of profitable investment opportunities around. The latter applies especially to financial institutions themselves, as interest rates at central banks are exceptionally low and COVID-19 has increased the risk of lending to most of the companies. Therefore all these fresh deposits end up being stashed as bank reserves.
This phenomenon is especially true for neo-banks like N26, Monzo or Revolut, because their loan-book is pretty thin, if non-existant at all, and thus the cash of their users is ultimately not reinvested in loans, ending up in the neo-banks’ accounts in central banks.
Usually, this extra reserve wouldn’t be a big deal: yes, there is a sort of ‘ethical’ issue because banks should channel capital from households to investments to put it at more productive use; but, to be honest, it is also very hard to find productive use for all the capital that is around today.
Besides this, the extra capital wouldn’t be a big problem if banks were not regulated by the Basel III framework. But they are. Basel III actually introduced a new non-credit risk ratio, the leverage ratio.
Leverage-ratio = Tier1 Capital/Total Asset > 3%
In simple terms, the leverage ratio wants to make sure that the leverage of the bank is not too high, so that the activities of the bank are not overly funded by debt positions.
This ratio is highly impacted by the reverse bank runs, because the bank capital that was optimized for a lower deposit base before the pandemic, is likely insufficient to guarantee a much larger asset base post-pandemic.
How are banks reacting?
There are essentially two ways to solve this problem: add extra capital or
optimize the Asset side – shrink it and make sure you don’t get other reserves.
Adding extra capital would be seamless to the depositors, but it’s not easy to ask your shareholders to put extra capital in a banking venture that is extremely cyclical, on the verge of a global recession caused by the pandemic. Therefore, the only feasible alternative for many banks is balance sheet optimisation, which concretely means stopping the creation of new accounts (as Goldman Sachs did in the UK with Marcus’ accounts) or, even more radically, disincentivizing extra deposits.
In the end, banks don’t want people’s money anymore, at least for now. What a time to be alive.
- BIS Basel 3 First Pillar – LINK
- BIS Basel 3 Summary table – LINK
- Wikipedia list of bank run – LINK
- Bloomberg: “Too much money can be bad for banks” – LINK
- Bloomberg: “Banks have too much money” – LINK
- The Guardian: “GS Marcus closes to new users” – LINK
- Riskquest Whitepaper on Basel 3 – LINK
- Deloitte on Basel 3 – LINK
- Investopedia on Basel 3 – LINK
- Wikipedia Standardized approach (credit risk) – LINK
- Bundesbank Standardized approach (credit risk) – LINK
- Capital.com Standardized approach (credit risk) – LINK
- Wikipedia Liquidity Requirements – LINK
- Investopedia Risk based capital requirements – LINK