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The Simplest Fix for Banking

Following the latest banking crisis, monetary authorities should seriously consider how modern digital technologies could be used to avert such problems in the future. A central bank digital currency would both eliminate many barriers to financial transactions and end the risk of bank runs once and for all.

BARCELONA – Last year, the Nobel Prize in Economics went to two economists who study the dynamics of bank runs, as well as to former US Federal Reserve Chair Ben Bernanke for his work analyzing how central banks have dealt with some of history’s worst banking crises, such as those in the Great Depression of the 1930s. Half a year later, we are witnessing another bank run whose contagious effects could destabilize economies, trigger recessions, and impose high costs on taxpayers.

Banks play a double role in the economy, taking short-term deposits and savings and then using those savings to lend money over the long term in the form of mortgages, business loans, and other investments. A run occurs when enough depositors come to fear that a bank may go bust, taking their savings with it. They all run to the bank to withdraw their funds, but because the bank has deployed those funds toward the other services it provides, it becomes insolvent. Having witnessed such runs, US President Franklin Roosevelt’s administration (followed by others around the world) created insurance schemes to alleviate depositors’ fears that they would not get at least some of their money back following a run.

But we now have a technological solution that could end bank runs forever. A country’s monetary authority could introduce a central bank digital currency (CBDC) and provide all depositors (taxpayers) with interest-bearing accounts at the central bank. Such a system would eliminate many barriers to financial transactions by making the broader payments system more fluid.