Five Steps to Stop the Next Run on America’s Banks, Bill Dudley

First, banking rests on confidence. For uninsured depositors, running at the first sign of trouble is a perfectly rational response. 

Second, systemic importance isn’t solely a matter of size. Even a small bank can cause big problems if other banks look like it.

Third, panic is difficult to stop once it starts.

Fourth, a bank’s prospects depend on more than just the credit quality of its assets. Interest-rate risk, and the composition of assets and liabilities, also are important.

Fifth, incentives matter. When bank executives’ compensation is tied to earnings and to the bank’s stock, they’ll be motivated to take more risk. 

What to do?

First, address the issue of uninsured depositors. Forget the notion that they can monitor banks and provide market discipline. In practice, they do so only in a binary way: not at all, or suddenly and completely. 

Second, restore systemic-risk supervision of mid-sized banks.

Third, head off panics by making central bank lender-of-last resort facilities always available and easier to access. Standing facilities that are not stigmatized would help.

Fourth, pay more attention to interest-rate risk, and the fundamental mismatch between banks’ long-term assets and short-term liabilities.

Finally, adjust incentives. If, for example, bank executives’ compensation shifted away from cash and equity toward subordinated debt that they had to hold for several years, they would be less inclined to take the kinds of risks that could lead to failure and the write-off of that subordinated debt.

Bill Dudley Bloomberg 22 mars 2023 


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