1. Christopher Martin, Manju Puri and Alexander Ufier
“On Deposit Stability in Failing Banks”
Christopher Martin, Manju Puri and Alexander Ufier
Comments by Larry D. Wall
Federal Reserve Bank of Atlanta

2. Disclaimer
The views expressed here is the discussant’s and not necessarily those of the Federal Reserve Bank of Atlanta, or the Federal Reserve System.

3. Looks at the failure of a $2 billion bank
Overview of the paper
Looks at the failure of a $2 billion bank
Failure primarily due to credit losses on exotic residential mortgage products (including adjustable rate mortgages?)
Data available on
End-of-day, deposit account level balances
Age of deposit
Whether deposit was held by an institution
Proportion of days where account had deposit or withdrawal
Time line of events including supervisory intervention

4. Overview of the paper Empirical results
Deposit insurance proved credible
Uninsured transactions accounts were more stable
Uninsured term deposits more likely to run
Older accounts less likely to run
Deposit runoff by account type did not exceed LCR assumptions but did sometimes exceed NSFR assumptions
Bank could replace runoff with new institutional term deposits that paid a 65 basis point premium

5. Comment: Paper is overly focused on deposits
Paper does not discuss why depositors run
Depositors care about PD and LGD of their bank
PD depends upon the regulators
Solvency and liquidity of the bank
Other factors, including available resources
LGD depends on
Value of bank’s capital and assets
Whether the claim is insured
Other relationships with the bank

6. Comment: Paper should discuss non-deposit factors
The value of the bank’s assets and capital
Public information
Private information maybe available to some depositors
Nondeposit sources of funds
FHLB funding both as substitute deposits and increasing deposit LGD by taking collateral
Capital Purchase Program (TARP)

7. Comment: Term versus transaction deposit run-off
Standard view is that uninsured transaction deposit are more subject to deposit run-off.
My understanding of the reasoning behind this view
One day a previously healthy bank is hit with adverse shock and becomes insolvent
Transactions deposits run immediately because they can
Term deposits run as they mature because they must wait
However, the paper finds term deposits are more likely to run

8. Comment: Term versus transaction deposit run-off
What happened in this case (and most U.S. failures)
Solvent bank is hit with a series of shocks that ultimately cause it to become insolvent
Forbearance given so reported losses < economic losses
Transactions depositors can run any time and have larger switching costs so they can afford to wait
Term deposits can only run at maturity and have low switching costs so are more likely to run
Implications
LCR and NSFR based on particular scenarios
But which deposits will run depends upon the scenario.

9. Comment: Market discipline versus “Improving funding stability”
Paper concludes that banks can undo disciplining effect of market by raising new insured deposits
But also says “we find that deposit insurance is effective in improving banks’ funding stability.”
These are two ways of describing the same phenomenon
Deposit insurance helps banks retain and attract funding

10. Comment: Market discipline versus “Improving funding stability”
Market did provide some discipline
Bank paid 2.8 percentage point premium before the crisis
Premiums (and deposit competition) reduced through time Likely average maturity of new/roll-over term deposits also decreased
But authorities acted to mute that discipline
Congress increased DI from $100,000 to $250,000
FDIC provided optional coverage for transactions accounts
If authorities are going to suppress market discipline then disciplining banks is up to supervisors

11. Comment: Implications for the future
This is not a “TBTF” bank. Depositor behavior may well be different at systemically important banks
The implementation of current expected credit loss (CECL) for recognition of losses (IFRS 9 and changes to US GAAP) will likely reduce banks’ ability to understate credit losses

12. Comment: Speculation about the future
The timing of depositor withdrawals will depend in part on the costs of switching to another bank
Development of FinTech may change switching costs for transactions accounts
Some changes may lower the cost of moving accounts
EU PSD2 mandates information sharing
Some changes may raise cost of moving accounts
Some US banks reaching separate agreement with individual FinTech firms

13. On Deposit Stability in Failing Banks
Further discussion
On Deposit Stability in Failing Banks By
Christopher Martin, Manju Puri and Alexander Ufier