What's Driving the Eurozone Bank Run?

Gavyn Davies at the Financial Times is out with an interesting article on the Eurozone bank run. First, let there be no doubt, the Eurozone is experiencing a bank run. Take a look at the chart below, which shows the cross-border flows in the Eurozone banking system.

Click to enlarge.

Banks are always at risk of a bank run, simply because of the way their assets and liabilities are structured. Banks borrow from depositors in the short-term, and lend to borrowers in the long-term. This borrowing short and lending long model always carries the risk that at a specific time enough depositors will act to withdraw their money, leading to the failure of the bank as it runs out of cash.

Although the bank run in the eurozone might partly be due to depositors' concerns over bank failures, Davies argues that main reason for the run is that depositors are concerned over exchange rate risk should the Eurozone break up. Instead of holding deposits within their own country, which comes with the risk of devaluation should the Eurozone break up, depositors are flocking to German banking institutions where the risk of devaluation is low.

This type of bank run presents a problem, because it's not one that the ECB can solve with simple liquidity injections, which is the standard response in a bank run. The ECB also cannot guarantee against future exchange rate losses to today's depositors. As Davies points out, Germany would certainly not stand behind such guarantees to Greek and Spanish citizens.

Let this be a lesson to all banks about the peril of borrowing short and lending long, which is at the heart of their fractional reserve banking model. Source: Breaking Economics