Author: Byron Gilliam, Blockworks
Compiled by Deep潮 TechFlow
DeepInsight Summary: Bitcoin supporters often compare fractional-reserve banking to a Ponzi scheme, claiming that even healthy banks would collapse under a run. However, a new study analyzing numerous bank run events has found that most runs fizzled out before posing any real threat to the banks. This presents a compelling rebuttal that investors relying on the narrative of banking fragility must confront.
“You’ve got it completely wrong, as if I’ve locked my money in a safe.” (George Bailey on fractional reserve banking)
The fundamental promise of banking is that everyone can withdraw their money at any time, as long as not everyone tries to do so simultaneously.
This is what George Bailey taught us.
You’ve completely misunderstood—it’s not like I’ve locked your money in a safe,” he told the customers rushing to withdraw from Bailey Brothers Building & Loan. “Your money isn’t here. It’s in Joe’s house, right next door. It’s also in the Kennedys’ home, Mrs. Macklin’s house, and hundreds of other homes.”
“You’re lending them money to build a house, and then they’ll do their best to pay you back,” he explained.
Anxious customers were not immediately reassured. George had to拿出 his own $2,000 to fend off the bank run. Even then, the bank was not truly saved until the end of the film: friends and customers donated enough money to cover the $8,000 shortfall on the bank’s balance sheet.
Austrian School economist Murray Rothbard would say, just let Bailey Bros. fail. “Fractional reserve banking is a scam, a Ponzi scheme, a fraud,” he once wrote.
He believes that banks have been able to carry out this fraud because bankers like George Bailey have distorted the way they are able to issue so many loans.
“Because everyone is accustomed to thinking that banks simply borrow our money and then lend it out,” Rothbard explained in a speech, “it’s hard to shift our thinking to realize that banks are actually engaging in a legalized form of counterfeiting.”
In other words, if people truly understood how fractional reserve banking works—how banks create money out of thin air—everyone would simultaneously demand their money back. Even the best banks would fail.
This pessimistic view of banks appears to be supported by academic research. Economists Douglas Diamond and Philip Dybvig wrote a classic study on the fragility of fractional-reserve banking: "Bank Runs, Deposit Insurance, and Liquidity."
This study formalizes Rothbard’s intuition: banks that use demand deposits to finance long-term loans are vulnerable to runs, even if their assets are sound.
Thus, concerns about bank failures can become self-fulfilling: “During a bank run, depositors rush to withdraw their funds because they expect the bank to fail,” the author explains. “In fact, sudden withdrawals force the bank to sell many assets at a loss, ultimately leading to its collapse.”
“This may not be related to the bank’s fundamental condition,” they added. Instead, “anything that makes [depositors] expect a run will trigger a run.”
Even "healthy" banks can fail.
Diamond and Dybvig reached this concerning conclusion primarily through theoretical models based on mathematics and game theory.
A new study shows that the model does not reflect reality.
Each run event, extracted by a large language model from newspaper reports, is documented on a website with details on why it began and how it was resolved.
An unexpected finding was that most bank runs fizzled out before threatening the bank. The authors found: “There were more bank runs that did not lead to bank failures than those that did.”
This does not align with the expectations of the Diamond-Dybvig self-fulfilling model.
Even among banks with "very weak" fundamentals, only 59% failed after a bank run.
I think Rothbard would expect this number to be 100%.
Meanwhile, the banks with the strongest fundamentals "rarely fail," even during bank runs.
The author's conclusion? "This pattern casts doubt on the strong view that liquidity issues alone can trigger severe financial distress."
I think this is their polite way of saying that Diamond, Dybvig, Rothbard, gold believers, and Bitcoin believers are all wrong about fractional reserve banking.
Cases pile up like mountains
Diamond and Dybvig got at least one thing right: “Bank runs in our model are caused by shifts in expectations,” they noted, “and expectations can depend on almost anything.”
While randomly browsing the bank run database, I found some excellent examples.
In 1910, a run occurred at the Merchants National Bank in Los Angeles after boxer Jim Jeffries visited the bank, drawing a crowd of boxing fans. The newspaper reported: “Dozens of depositors, thinking something was wrong, began withdrawing their funds. Only after the boxer left did the frightened customers calm down.”
Jeffries only came to open a bank account and deposit a portion of his championship prize.
In 1924, a bank run occurred at the Metals Bank & Trust Company in Butte, Montana, after rumors spread that someone had made a joking bet the bank would not open the next day. Newspaper reports stated that the bank continued operating for four hours past its normal closing time to meet withdrawal demands, “only ceasing payments to depositors when it became unsafe to do so after dark.”
The joke is that the bank will indeed be closed the next day because it's Lincoln's birthday.
In 1929, a run occurred at the Bay Ridge Savings Bank in Brooklyn, New York, triggered by rumors that the bank’s president had died. Fortunately, newspapers reported that the bank had “learned of the false rumor in advance” and had time to prepare $14 million in cash to meet withdrawal demands.
The truth is, the governor went to Connecticut to have a boil removed from his neck. (He survived the surgery.)
Once again, this is just a random sample from the database.
However, the peaceful resolution of these bank runs seems to contradict the strongest interpretation of the Diamond-Dybvig theory: bank runs rarely turn out to be self-fulfilling.
However, it does sometimes happen.
In 1930, a run on Chicago’s Independence State Bank was triggered by a fight two doors away. Newspapers reported: “Police patrol cars, responding to a call from a restaurant, pulled up in front of the bank building, sparking rumors that the bank was being run on.” Somehow, over $1.6 million was withdrawn from the bank’s $5.6 million in deposits, depleting its liquid assets to the point that state officials felt compelled to shut it down.
The Bank Runs website does not indicate whether Independence Bank’s balance sheet was fundamentally sound. However, the author’s research suggests that if it was sound, the bank would almost certainly have survived.
In many cases, simply demonstrating available cash is enough to weather a run.
For example, a bank run in 1907 was halted by "displaying large amounts of banknotes and cash at the counter for depositors to see."
In 1857, a "profitless bank run" at a bank in Alabama was halted because depositors saw a towering pile of gold Malakoff and a towering pile of silver Redan on the teller’s desk. (Malakoff and Redan were famous Russian fortresses.)
In 1924, the manager of a Brooklyn bank halted a bank run by stacking banknotes with denominations up to $1,000 in front of the bank’s window, “piled up casually” for everyone to see.
Do bank customers understand that no matter how much cash is piled up, if everyone tries to withdraw their money at the same time, there won’t be enough to pay everyone?
I guess they understand.
(Byron Gilliam)