Economists Find That Communication Helps Discourage Bank Runs

By James Devitt

      The more information banks depositors have about an economic crisis, the less likely they are to make a run on their deposits in those banks, according to an experimental study by economists at NYU and the Federal Reserve Bank of New York. Their results also showed that the presence of “insiders”—those who know the quality of the bank—and the availability of deposit insurance, even if limited, can significantly mitigate the severity of bank runs. The study, “On the Dynamics and Severity of Bank Runs,” appeared in the Journal of Financial Intermediation.
      The study was co-authored by NYU’s Andrew Schotter, a professor of economics and director of the University’s Center for Experimental Social Science, and Tanju Yorulmazer, an economist at the Federal Reserve Bank of New York.
      “The 2007 bank run on Northern Rock in the U.K., the first bank run in the U.K. since the collapse of the City of Glasgow Bank in 1878, once again showed that crises and bank runs are an important feature of our financial landscape,” the authors wrote.
      To examine the factors that may dampen runs, researchers at NYU’s Center for Experimental Social Science used groups of six subjects, or “depositors,” who were told they must withdraw their money during one of four time periods. In the experiment, the subjects were told that the bank promised to pay interest on deposits as long as it had the funds when depositors withdrew, meaning a depositor could earn more, through compounded interest, the longer his or her money was kept in the bank and as long as it remained solvent. If the bank did not have the required funds, then it paid each depositor who wanted to withdraw at that time an equal share of what it had available on hand while the depositors who showed up at later periods would receive nothing.
      The researchers implemented a variety of experimental treatments to replicate real-world conditions. In one treatment, the “high-information sequential treatment,” subjects had to decide, period by period, whether to remove their funds from their bank, but were informed of how many others had already removed their funds and whether they were paid their promised interest. In the “low-information sequential treatment,” subjects again had to decide, period by period, but were given no information about their predecessors. These sequential treatments were also run in the presence of partial “deposit insurance,” in which participants were told their deposits were insured up to 20 percent or 50 percent of their value, and in a condition where there were “insiders” within the group of six. These insiders knew the quality of the bank in which each member of that group’s funds were deposited.
      Researchers found that the participants in the experiment withdrew their funds more slowly when they were informed about the previous actions of their cohorts and when there was deposit insurance—even if it was only partial. Money was also withdrawn more slowly when there were insiders in the experiment and when their existence, though not their identity, was known to the group.