How a New Regulatory Framework Could Contain Bank Runs and Promote Recovery

The rapid escalation in uninsured deposit runs in March 2023 led to chaotic intervention with potentially severe fiscal implications. The runs spotlighted once again the limit on prudential norms. Since the collapse of SVB, Credit Suisse, and other smaller banks that year, many reform proposals have focused on stronger ex-ante prudential measures, such as higher capital and liquidity rules (Admati et al., 2023). Yet other proposals have included an expansion of public insurance for corporate deposits (Heider et al., 2023; Dewatripont et al., 2023). In our view, higher capital and liquidity rules would be most effective but also controversial because of their cost, while expanding insurance would also be costly and lead to more risk.

In a recent paper, we propose an alternative that focuses on the role of the supervisor (Pillar II) in prompting recovery of solvent yet undercapitalized banks through the timely activation of interim measures. Our aim is to restore credibility to timely intervention and empower the supervisory authority to prompt the recovery of viable banks.