A Tale of Two Runs: Depositor Responses to Bank Solvency Risk

• Author: MANJU PURI,NICHOLAS RYAN,RAJKAMAL IYER
• DOI: http://doi.org/10.1111/jofi.12424
• Published date: 01 December 2016
• Date: 01 December 2016

THE JOURNAL OF FINANCE •VOL. LXXI, NO. 6 •DECEMBER 2016

A Tale of Two Runs: Depositor Responses to Bank

Solvency Risk

RAJKAMAL IYER, MANJU PURI, and NICHOLAS RYAN∗

ABSTRACT

We examine heterogeneity in depositor responses to solvency risk using depositor-

level data for a bank that faced two different runs. We find that depositors with loans

and bank staff are less likely to run than others during a low-solvency-risk shock, but

are more likely to run during a high-solvency-risk shock. Uninsured depositors are

also sensitive to bank solvency. In contrast, depositors with older accounts run less,

and those with frequent past transactions run more, irrespective of the underlying

risk. Our results show that the fragility of a bank depends on the composition of its

deposit base.

WHO RUNS ON A BANK,AND why? We know that runs are related to bank solvency

in aggregate (Saunders and Wilson (1996), Calomiris and Mason (1997)). Yet

deposits are not a homogeneous mass—they are held by people with different

histories and different relationships to their banks. A person with only a mod-

est checking account, for example, may not bother to learn about her bank’s

financial health, whereas those with higher balances or a broader relationship

(e.g., they also hold a loan) may know more about their bank and as a result

have more reason to act on that knowledge, since their financial well-being

is tied up with their bank’s.1Following this line of thought, if some kinds of

depositors are more or less sensitive to the solvency risk of their bank, then the

make-up of a bank’s deposit base may be an important determinant of stability.

Treating deposits as held by heterogeneous depositors, each with their own

∗Rajkamal Iyer is with MIT Sloan. Manju Puri is with Fuqua School of Business, Duke Uni-

versity, and NBER. Nicholas Ryan is with Yale University. We are grateful to Mr. Gokul Parikh

and the staff of the bank for all their help and to Anup Roy and Pramod Tiwari of IFMR for

supervision of the depositor survey. We thank the Editor, Michael Roberts, and four anonymous

referees for comments that greatly improved the paper. Wethank Nittai Bergman, Doug Diamond,

Mark Flannery,Xavier Giroud, Ali Hortac¸su,Daniel Paravisini, Antoinette Schoar, Andrei Shleifer,

and Tavneet Suri for comments. We thank seminar and conference participants and discussants

at the ABFER (Singapore), ASSA meetings (San Diego), Corporate Finance Conference (Bristol),

CAFRAL, Reserve Bank of India, Columbia University,GSE Summer Forum, Barcelona, UC Berke-

ley, CEPR-EBRD-EBC-ROF Conference, Duke University, European Central Bank, FDIC/JFSR,

FIRS (Croatia), Indiana University, Lingnan University, Minneapolis Fed, MIT, NBER Summer

Institute, New York Fed, Riksbank, Tel Aviv, and the World Bank. The authors declare that they

have no relevant or material financial interests related to the research in this paper.

1We use female pronouns throughout though depositors may be of any gender.

DOI: 10.1111/jofi.12424

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2688 The Journal of Finance R

notion of solvency risk, may help us understand the nature of runs and aid in

the design of banking regulation.

Despite the importance of understanding the micro-level response to sol-

vency risk, evidence on this subject is scarce, for several reasons. First, and

most plainly, it is hard to obtain detailed microdata on depositors, their rela-

tionships with a bank, and their withdrawal behavior during a run. Second,

interpretation of most shocks is not clean as to date we lack a clean ex ante

measure of banks’ solvency risk that would allow us to examine whether depos-

itors respond to that risk independently from the actions of other depositors or

the outcome of a run. Third, it is difficult in practice to compare the response

of depositors to shocks with different degrees of underlying solvency risk.

In this paper, we study the behavior of depositors across two shocks with

different degrees of solvency risk that were experienced by a single bank. To

do so, we use a new data set from a bank in India with microlevel depositor

data. This data set allows us to identify depositor characteristics along with

the timing of every depositor transaction. We use this data set to study the

behavior of depositors with different characteristics across the two shocks,

which were eight years apart and each triggered runs on the bank. We define

a high-solvency-risk shock as a shock that renders the bank insolvent and a

low-solvency-risk shock as one that does not affect the bank’s solvency, absent

any further response by depositors. Of course, depositors may not be aware of

the nature of a shock at the time they decide whether to run—but whether

the actions of different types of depositors reflect a bank’s underlying solvency

risk is precisely the question of interest.2We study depositor withdrawals for

the bank’s entire depositor base under both shocks and, among the subset of

depositors who hold accounts at the time of both shocks, for the same individual

depositors in the two events.

The bank we study experienced a high-solvency-risk shock and was subject to

runs in early 2009, during and after a regulatory intervention that ultimately

placed the bank in receivership. We firstexamine depositor behavior during this

high-solvency-risk shock and then compare it with a prior low-solvency-risk

shock. The timeline of high-risk shock that we exploit is as follows. The bank

had a build-up of bad loans. This build-up was uncovered by the central bank

during an audit. While the bank’s negative net worth was documented by the

central bank, it remained private information. This audit was followed, after

several months, by public news that the central bank was severely restricting

the bank’s activity.

We find that there is a large run by depositors immediately following the

public news of the high-solvency-risk shock. Uninsured depositors are far more

likely to run than insured depositors. Depositors that have loan linkages with

2If a large fraction of depositors run, then even when the initial shock does not affect the

solvency of the bank, the run can become self-fulfilling, put the solvency of the bank into question,

and bring about failure. We therefore define underlying solvency risk as a threat to the solvency of

the bank as a result of the initial shock, without the response of depositors (while acknowledging

that panics can also bring down banks).

A Tale of Two Runs 2689

the bank or who are bank staff are also more likely to run. Further, depositors

are more likely to run if a member of their network has already done so, or if

they have a higher volume of transactions with the bank. In contrast, depositors

with a longer relationship with the bank are less likely to run than others.

Thus, while loan linkages appear to increase the likelihood of running, account

age reduces the likelihood of running, even in the presence of high solvency

risk. These results suggest that, beyond the mere fact of a relationship, how

relationships are established matters for depositor behavior.

We next broaden the event window to study whether some types of depositors

run even before negative news becomes public. We find that there was indeed a

silent run, beginning at the time of the regulatory audit but prior to the public

release of information that was driven by uninsured depositors, depositors with

loan linkages, and staff members. Staff of the bank withdrew first in response

to the audit, followed closely by uninsured depositors and depositors with loan

linkages. Thus, while in principle a regulatory audit is private information

available only to the bank, in practice uninsured depositors, depositors with

loan linkages, and bank staff withdraw more immediately following an audit.

The results above suggest that there are sharp differences in the responses

of different depositor types to a high-solvency-risk shock. Observing how with-

drawals respond to this one shock, however, leaves two important questions

unanswered. First, is it depositor relationships themselves that matter, or do

those relationships reflect omitted characteristics of depositors, such as ed-

ucation or financial literacy, that drive withdrawals? Second, are depositors

responding to the fundamental nature of the shock, or would they withdraw

just the same in response to a low-solvency-risk shock?

To address the first of these questions, we focus on a sample of depositors

that hold accounts during the high-solvency-risk shock and collect household

survey data on demographics, financial literacy, and assets. We find that each

of these sets of depositor characteristics matter for explaining which depositors

run after the shock. Depositors are significantly more likely to run if they are

more educated, are engaged in a business or professional occupation, are more

financially literate, or hold more assets. However,when we add these additional

characteristics to the set of factors that explain why depositors run, we find

that the strong effects of depositor banking relationships on liquidation are

unchanged.

To address the second question on whether depositors respond to the nature

of the shock, we contrast the depositor response to the high-solvency-risk shock

with the depositor response to a low-solvency-risk shock that hit the same bank

eight years earlier. At this time our bank experienced a run in response to the

idiosyncratic failure of another bank in the same city due to fraud. Our bank

had no fundamental linkages to the failed bank and the run lasted only a few

days. Our bank was solidly solvent at the time, but depositors’ beliefs about its

solvency risk could have been very different from the true state.

We find that, during a low-solvency-risk shock, depositors with loan linkages

are less likely to run. The behavior of depositors with loan linkages is thus sen-

sitive to the nature of the shock, in a direction that suggests they are informed