The Simplest Fix for Banking

By Jan Eeckhout

BARCELONA – Last year, the Nobel Prize in Economics went to two economists who study the dynamics of bank runs, as well as to former US Federal Reserve Chair Ben Bernanke for his work analyzing how central banks have dealt with some of history’s worst banking crises, such as those in the Great Depression of the 1930s. Half a year later, we are witnessing another bank run whose contagious effects could destabilize economies, trigger recessions, and impose high costs on taxpayers.

Banks play a double role in the economy, taking short-term deposits and savings and then using those savings to lend money over the long term in the form of mortgages, business loans, and other investments. A run occurs when enough depositors come to fear that a bank may go bust, taking their savings with it. They all run to the bank to withdraw their funds, but because the bank has deployed those funds toward the other services it provides, it becomes insolvent. Having witnessed such runs, US President Franklin Roosevelt’s administration (followed by others around the world) created insurance schemes to alleviate depositors’ fears that they would not get at least some of their money back following a run.

But we now have a technological solution that could end bank runs forever. A country’s monetary authority could introduce a central bank digital currency (CBDC) and provide all depositors (taxpayers) with interest-bearing accounts at the central bank. Such a system would eliminate many barriers to financial transactions by making the broader payments system more fluid.

This system would not be anything like the Wild West of cryptocurrencies and speculative pyramid schemes that have cropped up in recent years, nor would it be socialized banking. There are already plenty of fintech companies (Revolut, Wise, N26) offering sleek apps and innovative services that enable instantaneous smartphone payments to other users who bank with competing operators. These same financial operators could access CBDC balances held by the central bank and compete for customers by minimizing transaction costs.

(Continued in support post...)