1. Deposit Withdrawals from Distressed Commercial Banks Martin Brown (joint work with Benjamin Guin & Stefan Morkoetter) October 2015

2. Deposit withdrawals in the 2007-2009 crisis

3. 3 Policy response Liquidity coverage ratio (LCR): Client relationships / Switching costs matter Source: Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools

4. 4 Research question Do strong bank-client relationships and switching costs mitigate withdrawal risk from distressed banks ?

5. Background 5

6. 6 Profit & loss in the crisis Cumulated profit / loss in % of pre-crisis (2006) equity

7. 7 Profit & loss in the crisis: Other banks Cumulated profit / loss 2007-2009 in % of pre-crisis (2006) equity 17 large banks (> 10 bn CHF assets)

8. 8 Customer deposits in the crisis End of quarter customer deposits (2006:Q4 = 100)

9. 9 Deposits in the crisis: Other banks % change in customer deposits 2009:Q4 – 2007:Q4

10. Data & Methodology 10

11. 11 Household survey data 1,475 households in German-speaking area of Switzerland Information on bank relationships  all pre-crisis bank relationships  scope / duration of the relationship  reallocation of funds between banks during the crisis Household characteristics  socio-economics (income, wealth, education, gender, age)  financial literacy (standard questions, deposit insurance).  behavioral traits (risk aversion, time preferences).  geographic location (ZIP code)

12. 12 Pre-crisis bank relationships We oberve 2’414 pre-crisis deposit relationships for 1’475 households 368 households have deposits with UBS / 178 with Credit Suisse UBS (368) Credit Suisse (178) Savings banks (610) Cantonal banks (836) Other (211)

13. 13 Questions on deposit withdrawals “In 2008/2009 did you reallocate assets (deposits or securities) from one bank to another ? “Which type of assets did you transfer from bank X ? “ -Transaction account, Savings account -Retirement account, Securities account “Which share of funds at bank X did you tranfer?” -Less than 25%, 25%-50% -50% -75%, more als 75% “ Did you cease your relationship with bank X ? “ Withdrew deposit (mean = 5%) Withdrew deposit > 50% (mean =3%) Account closed (mean = 2%)

14. 14 Empirical approach Do households withdraw more frequently from distressed banks ? Do switching costs mitigate withdrawals from distressed banks ? X i : household-level controls; a i : household fe

15. Results 15

16. 16 Frequency of deposit withdrawals

17. 17 Households withdraw more frequently from UBS

18. 18 Which UBS clients withdraw ? Indicators of switching costs: Single account: Only 1 deposit account prior to the crisis No local banks: No branch of non-distressed bank in same Zip-code Credit linkage: Mortgage or consumer loan with the bank

19. 19 Switching costs mitigate withdrawal risk

20. 20 Deposit insurance and financial sophistication We conduct subsample analysis for households with  high vs. low wealth  strong vs. weak knowledge about deposit insurance  high vs. low financial literacy Our main results are confirmed in each of these subsamples  households withdraw more often from UBS than CS or non- distressed banks  deposit withdrawals are substantially mitigated by strong bank- client relationships and (related) switching costs

21. 21 Conclusions Distressed commercial banks may suffer substantial retail deposit withdrawals.. even when they are Too big too fail Broad client relationships and (related) switching costs do mitigate withdrawal risk The emphasis on stable customer relationships in Basel III has empirical support

22. 22 ….. the next step ….

23. martin.brown@unisg.ch http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2354197 23

24. 24 Survey representativeness: Households Sources of official data: Swiss Federal Statistics Office, OECD

25. 25 Survey representativeness: Bank relations

26. 26 Deposit withdrawals (multivariate)

27. 27 Deposit withdrawals (multivariate)

28. 28 Deposit withdrawals (multivariate)

29. 29 Where did households shift funds to ?

30. 30 Questions on Financial Literacy

31. 31 Results on Financial Literacy

32. 32 Questions on Deposit Insurance Is there deposit insurance in Switzerland which secures your money in bank accounts up to a certain threshold in case of a bankruptcy of the bank? How high is the coverage of the deposit insurance currently per person for all of his/her deposits with a bank in Switzerland? Has the deposit insurance coverage been increased, decreased or stayed the same during the last three years?

33. 33 Results on Deposit Insurance

34. 34 The reaction of investors Source: SNB Financial Stability Report 2010

35. 35 Related theory Bank performance & deposit withdrawals  Information-based runsChari & Jagannathan, JF 1988  Ex-ante monitoringCalomiris & Kahn, AER 1991  Ex-post disciplineDiamond & Rajan, JPE 2001 Switching costs of retail depositors Sharpe, RIO 1997 (Klemperer, QJE 1987)

36. 36 Related evidence Bank-level evidence on deposit withdrawals  Calomiris & Mason (AER, 1997), Saunders & Wilson (JFI 2000)  Goldberg & Hudgins (JFE 2002), Peria & Schmukler (JF, 2001)  Oliveira et al. (RoF, 2013) Client-level evidence on deposit withdrawals  Iyer and Puri (AER, 2013), Iyer, Puri & Ryan (2013)  Davenport & McDill (JFSR, 2006) Switching costs in the deposit market  Kiser (RIO, 2007)  Hannan & Adams (J Ind.E, 2011), Carbo-Valverde et al. (EER, 2011)

37. 37 Methodology Distressed bank j=1 Household i=1 Household i=2 j=2 j=3 Household i=5 Household i=3 j=5 j=6 Household i=6 j=7 State-owned bank Savings bank j=4 Household i=4 j=8 Distressed bank N=2,414 pre-crisis deposit relationships

38. 38 Why do households withdraw ? ‘You reallocated your assets because:  you did not agree with the corporate policy of the bank, although it was safe  you considered it too risky to keep your funds were they were  other banks offered better prices /terms.’ (fully disagree, partially disagree, partially agree, fully agree)

39. 39 Household and bank branch locations We hand-collected the ZIP codes of all bank branches in Switzerland (in 2011) Geocoding of ZIP codes was done with stata/googlemaps