Irish Liberty Forum

The Fragility of Modern Banking

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A major bank in Hong Kong has successfully managed to survive a run, but the article in today’s International Herald Tribune recalls how another bank was not so lucky, back in 1991:

A long line at a bus stop then in front of a branch of the troubled Bank of Credit & Commerce International was mistaken by passersby for a bank run. What followed was a frenzied effort by Hong Kong residents to pull their money out of the bank, which quickly collapsed and set off runs at other Hong Kong banks, which survived.

That’s correct: a queue at a bus stop was enough to topple the bank and threaten the entire Hong Kong banking sector. People correctly understood that the failing bank did not have enough reserves to pay each depositor; their only mistake was in believing that other depositors had already begun to exit.

It is indeed a problem of collective action. If we trust other depositors not to move, then we don’t need to move. If we don’t trust them not to move, then we may be tempted to move, thus forcing them to move also.

It’s a classic dilemma, but a perverse way to run a banking system. It means that nervous deposit holders must forever be on the lookout for unusually long queues at bus stops.


Written by Graham

September 25, 2008 at 5:34 pm

Posted in economics, finance

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