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13 Mar 2023  (945 Views) 
Monetary Auth of Singapore

Prevent a run on the bank
Silicon Valley Bank faced a "run on the bank". Due to premature withdrawals of deposits, they faced a liquidity crisis and had to sell their bonds, ahead of maturity dates, at a loss.

They planned to raise additional capital to cover their loss of $1.8 billion USD. Given some time, and with the right price, they would be able to raise the additional capital.

They did not have the time. Their customers panicked and withdrew their deposits. They could not meet all the demands.

One problem faced by a bank is that they have to invest the deposits to earn revenue to pay the interest on the deposits and have a margin to cover their expenses and leave a profit.

To prevent a "run on the bank", the bank should be allowed to impose a penalty for early withdrawal. Currently, the penalty is rather small (e.g. forfeiture of interest for the current period).

While this forfeiture may be adequate under normal times, the bank should be allowed to impose a large withdrawals to prevent a run on the bank. For example, the bank should be allowed to impose a penalty of, for example, up to 30% of the deposit.

If depositors have to pay a high penalty for premature withdrawal, especially at a time when the bank faces a liquidity crunch, they may decide to keep their deposits until the maturity date. This would give sufficient time for the bank to raise additional capital and prevent a collapse.

If the customer does not wish to face this penalty, they can keep their money in the current account and earn no interest.

Another arrangement is for the central bank to provide liquidity to the bank (at the market rate of interest) to meet withdrawals.

Maybe, it should be a combination of both measures, i.e. tap on central bank for emergency funds and impose a sufficient penalty on premature withdrawals.

Tan Kin Lian

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May be a mute question. SVB is being auctioned off Sunday night USA time. Yellen has stated there will be no bailout. Regulators have tonight to stabilize the situation or might be a contagion.

David Winkler  13 Mar 2023  

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