A brief response to a common question after the takeover of Silicon Valley Bank and Signature Bank by the regulators.


by Richard Werner


To consider the question whether banks should be allowed to fail, we have to be aware that bank failures have a significant adverse impact on society.

Firstly, there is the impact on the economy, on economic growth and employment. We saw this in the 1930s, when the US Federal Reserve oversaw the bankruptcy of ca. 10,000 small banks that it let fail or even drove into failure. This had a devastating impact on the economy. Let’s not forget that banks create credit and this is how our money supply is created and expanded. Most of the money we use is actually Bank Digital Currency (BDC), which accounts for ca. 97% of the money supply. For economic growth to take place, this money supply needs to grow, which means banks need to extend loans for transactions that contribute to GDP. If the banks collapse, the money supply shrinks, and thus economic growth declines, unemployment rises and we experience a recession. Of course, the impact is larger, the more banks go bust. (Also, this means we should continue to create new banks, since more banks generally result in higher economic growth).

That leads me to the second point: Banks are network businesses and we experience the problem of ‘contagion’ quickly: As one bank fails, this will have ripple-on effects on other banks. Quickly another bank can fail, and another one etc.

Thirdly, there is the reputation effect: bank failures result in loss of faith in the financial system. As a result, people may sell the currency concerned, and/or revert to gold or private cryptocurrencies. This would weaken the efficacy of monetary policy. More importantly, the many sound and economically invaluable small local banks may thus also be affected.

Fourthly, there is the issue of equity and justice. Many ordinary people do not have the time or knowledge to understand the differences between different banks, while everyone mostly still needs a bank account. They can hardly be expected to make an informed assessment of which bank is riskier than another. Thus if we let banks fail, speculators shorting bank stocks will benefit (as they likely cause the problem in the first place), while ordinary hard-working folks will lose their deposits in excess of the insured maximum payoff amount ($250,000 per person and bank at the moment).

Fifthly, it is well-known that the banking system has one inherent flaw: it is possible for a perfectly good bank with sound assets to get into trouble and to fail, if only a sufficiently large number of depositors demand that their deposit claims on the bank are transferred out of the bank. This is why in the US over a century ago, Congress agreed to establish the US central bank, the Federal Reserve: it was argued by proponents of the Fed that it would step in and lend, as a lender of last resort, to banks affected by a run on deposits.

Sadly, when there were literally thousands of bank runs in the Great Depression of the 1930s, the Federal Reserve broke its promise of acting as lender of last resort. It claimed that it only is obliged to help those banks that had become “member” banks of the Fed system. The Fed watched as almost 10,000 small local banks failed and their depositors failed to recover their savings. Destitution and even starvation ensued in some areas.

Some of these above problems were lessened by the introduction of the deposit insurance scheme in 1933, but they remain the main five reasons why generally regulators should try to avoid bank failures.

What about the argument that rescuing banks means we don’t really have free market capitalism? Well, one could say that in the US free markets were given up with the introduction of the Federal Reserve (and some would argue, the simultaneous introduction of the income tax). As soon as a central bank is introduced, central planning and top-down manipulation of markets have a foothold. According to the Theory of Bureaucracy, what we can next expect is for the bureaucracy to grow, like cancer, and take over ever greater parts of society. Mind you, for much of its history, the US did not have a central bank. Economic growth was higher then…

Diversity in banking is key: it is always better to have more banks, and ideally also banks of different types. Most of all, it is extremely helpful for an economy and society to have many local banks. This is why the US economy has been generally performing well in the past two hundred years: It has always boasted thousands of small banks. Sadly, the central planners have been reducing the number of banks, and this is the sixth reason why it’s not usually a good idea to let banks fail or even to let them merge: it reduces the number of banks in the economy and with it increases concentration of the banking system. Fewer and bigger banks will lend less and less to small firms, which tends to mean that productive credit creation the produces jobs, prosperity and no inflation, also declines, and credit creation for asset purchases, causing asset bubbles, or credit creation for consumption, causing inflation, become more dominant.

Ultimately the central planners maximise their power by introducing CBDCs. And that’s where a conflict of interest becomes apparent: Shouldn’t the regulators, as umpires, keep out of the business of banking? Shouldn’t they be prevented from competing against the banks which they regulate? If the umpire in a soccer game suddenly starts to score goals, using the yellow and red card liberally in the process, few would think this was a fair game. Guess who would win that game! Likewise, the central banks should not at the same time be bank regulators and prepare to compete against them via central bank digital currencies.

It is concerning that for the past decade or so central banks have steadily been working towards the introduction of CBDCs, while at the same time adopting policies that have killed thousands of small banks. In the eurozone, more than 5,000 banks have disappeared since the ECB started business a little over two decades ago. Once CBDCs are introduced, it just takes another bank run, such as in the case of Silicon Valley Bank, and all deposits will be shifted to the central bank, driving banks out of business. Then we will have arrived at the most centralised form of banking: A Soviet-style economy with only one bank. While that may be the dream of any central planner, it is inefficient, does not work, as we have seen in the Soviet Union, and it also crushes the human spirit: Central planners get too much wrong, which is at the very least demotivating and frustrating, but is quickly much worse than that – it easily turns into totalitarianism.

Considering the collapse of Silicon Valley Bank and also Signature Bank on 10 March 2023, what concerns me most is that Silicon Valley Bank seems to have been solvent and that the Federal Reserve did not seem to have provided the short-term liquidity that a solvent bank should receive from the central bank when there is a bank run. The depositors were largely companies and institutions and not covered by the deposit insurance, which means that a classic bank run could occur. Almost $50bn left in one day on Thursday 9 March 2023, thanks to efficient digital bank technology with which we transfer BDC (bank digital currency), proving once again that there is no problem with the digital money that we have been using for decades. But why did the Fed only provide such liquidity after the Federal Deposit Insurance Corporation had stepped in and closed the bank? Over the weekend, the regulators set up a new bank that took over. Just like in the 1930s, the promised lender of last resort function, on the back of which a reluctant Congress was persuaded to adopt the Federal Reserve Act in 1913 (and a very badly attended Congress, as the vote had barely been announced and was held on 23 December, when most had left for Christmas), was once again not forthcoming in time. The result: An ever more concentrated banking system. And ever more power for the central planners. This despite the fact that the case for the continued need to have central banks is not very strong.

China’s success started when Deng Xiaoping came to power in 1978 and immediately demanded that ideology and politics should be de-emphasised, and economic policies should be adopted that had a record of actually working well. So he ditched the Soviet-style monobanking system, where one bank (Gosbank – see its logo above) controlled all transactions in the economy, and created thousands of banks, mostly small local banks, lending to small firms. The rest is history: With such a vibrant banking system consisting of thousands of local banks, China delivered four decades of double-digit economic growth, lifting more people out of poverty than any other country in history.

Decentralised structures are more resilient and more successful than centralised ones, for one, because central planning crushes the human spirit. Central planners also can never get things right in detail. Decentralised forms of organisation improve motivation and boost creativity. Since money is at the heart of the economy, and banks create it, we need to ensure we have a decentralised banking system consisting of many small banks. It is time to stop the ongoing push towards concentrated banking systems, which can only serve the agenda to introduce central bank digital currencies (CBDCs), which are “programmable” and a totalitarian control tool rather than a currency.