Digital bank runs: How social media fuels panic and threatens financial stability

A crisis of confidence in the US banking sector has led individuals to withdraw their money from financial institutions including Silicon Valley Bank, Credit Suisse, First Republic Bank, and California-based PacWest Bancorp. This series of events has given birth to a new term in the finance lexicon: digital bank run.

In contrast to traditional bank runs, where people would form queues outside branches to withdraw their money, digital bank runs gather momentum even more rapidly due to the impact of social media. This creates an increased sense of urgency and impending crisis.

A series of negative posts on Twitter regarding Silicon Valley Bank led to the withdrawal of US$40 billion in deposits, totalling 23% of overall deposits, within a span of hours, culminating in the bank’s failure. This is a stark contrast to the 2008 example of Washington Mutual, which took nine days to lose US$17 billion (9% of total deposits).

Digital bank runs pose a new threat to financial stability, causing sleepless nights for investors and regulators alike. Much like the toxic assets that catalysed the 2008 global financial crisis, digital bank runs are the product of new technology (specifically, social media platforms like Twitter) combined with the age-old complexities of the financial sector, such as fractional banking.

Fractional banking means that banks only hold onto a percentage of the money entrusted to them, investing the rest to generate profits. Consequently, if a large enough group of depositors withdraws their money – usually driven by concerns about potential bank failure – the bank will not have sufficient funds, which ultimately leads to its failure. Worries about a single bank’s status may then spread to other banks, creating widespread financial panic, multiple bank failures, and even a potential economic recession.

The crisis at Silicon Valley Bank highlights how the risks associated with fractional banking can be further exacerbated by social media. It was once difficult for negative information to spread among customers in the absence of visual cues, such as long queues outside bank branches. However, recent research indicates that an increase in social media posts with negative sentiment about Silicon Valley Bank prior to its collapse on March 10 was followed by a drop in stock prices (viewed as a comprehensive measure of deposits).

To prevent the domino effect that can lead to digital bank runs, bank executives, investors, and regulators need to be cautious about the information they share publicly. Even those who aren’t active on social media can have their conversations and discussions picked up and amplified by users, impacting overall sentiment about a bank.

The recent example of Credit Suisse highlights the importance of communication, or the lack thereof, for a bank’s share price and investor confidence. The decision by management not to answer questions following a critical investor presentation on April 25 garnered media attention before regulators seized the bank’s assets, eventually selling them to JP Morgan on May 1.

Governments can also play a role in helping to avert digital bank runs. Deutsche Bank’s share price dropped precipitously on April 24, only minutes after the cost of insuring its debt against default jumped to a four-year high. However, Germany’s Chancellor Olaf Scholz publicly dismissed any comparisons between Deutsche Bank and the failed Swiss bank, thus calming the markets.

When it comes to investors or depositors, the importance of expertise, contacts, and insider knowledge cannot be underestimated. Accessing various sources of information is crucial not just for professional investors, but also for everyday individuals managing their own finances. Utilising social media to gather insight from diverse opinions can help stakeholders to react more methodically and strategically to situations, just as Wall Street professionals do.

It is crucial for all involved in the banking and finance sector to be aware of and understand the implications of digital bank runs. This will enable them to take proactive measures, learning from recent examples, to prevent further instances of financial panic driven by the rapid spread of negative sentiment through social media channels, reports Channel News Asia.