If the bank uses deposits to fund poorly performing projects, depositors can become concerned that eventually their bank is going to fail and they will not get their deposits back. If a bank lends too much of its deposits to finance long-term projects, depositors might begin to worry that they will not be able to withdraw their money according to their needs. Therefore, banks hold enough cash on hand, or â€œliquidity,â€ to be able to honor withdrawal requests and offer confidence to depositors that their money will be there when they want it. If depositors lose confidence in their bank, the only rational thing to do is to withdraw their money and move it to a safer place. With each depositor withdrawal, the bank becomes more leveraged, the mismatch between its assets and liabilities becomes more pronounced, and liquidity on hand is further diminished.
With the credentials that one assumes qualified them to be on the commission in the first place, you’d hope to do better than what you’d get from putting “bank run” into The Google.Â But do you?
For one thing, there’s no mention of bank capital in this story.Â The depositors get nervous not because of loan losses per se, but loan losses that exceed the bank’s ability to dig into its own resources to cover them.Â That raises another point … “with each depositor withdrawawl, the bank becomes more leveraged.”Â Since the depositors have lent money to the bank, how does loss of deposits make the bank more leveraged?Â In a bank run, the bank in fact is undergoing a brutal deleveraging.Â It’s certainly becoming less liquid, and if it goes into its capital — that word again — to meet its liquidity needs, then its leverage ratio is increasing.Â But their’s a very hard story to tell without discussing capital.
One more thing.Â Moral hazard is mentioned precisely once in the report, in the context of a perceived government backstop leading to a too big to fail dynamic.Â But more hazard is an intrinsic characteristic of having someone else’s money in a limited liability framework.Â Such as being a financial intermediary, bank or non-bank.Â The solution to moral hazard is supposed to be that the intermediary’s, yes, capital,Â exposed to the first losses.Â There is no discussion in the report of why this solution failed.Â
In short, preventing the next financial crisis has involved thinking about a mix of more capital and more regulation — using the former may lessen the need to use the latter, and vice versa.Â But in a report that’s not willing to talk much about capital or regulation, the authors likely have problems with both.