The Hindu : Run on bank deposits

Online edition of India's National Newspaper
Tuesday, Apr 29, 2003

Business

Business

Run on bank deposits — Key issues

By Our Corporate Reporter

CHENNAI APRIL 28. The recent incident of the short-lived run on deposits of ICICI Bank in some areas of Gujarat is the first time a large bank in the Indian system has faced with such a situation. Bank deposits are highly confidence-sensitive and triggers for a sudden large-scale loss of depositor confidence are hard to predict. In an increasingly volatile environment, the possibility of this risk precipitating has indeed heightened, says Credit Rating and Information Services of India (Crisil).

Once a run on deposits begins, the quality of the immediate response of the bank's management and the regulator, centrally determines the magnitude and the impact of the episode. Significant delays in making cash available or ineffective public communication could impair confidence of depositors in the bank resulting in acceleration of the withdrawal rush, it added.

The four key issues in managing a run on deposits include availability of varied sources of liquidity, nature of system support, logistics of cash management over large networks, and the communication strategy.

First, the maintenance of varied sources of liquidity is necessary if a bank is to react quickly and limit the impact of a run. These sources — inter alia — include the cash reserve ratio (CRR) and excess cash balances, securities for maintaining the statutory liquidity ratio (SLR) and excess liquid securities, and cash vaults at various locations.

Second, system support is an important comfort factor in the event of a `run'. The speed and extent of system support, however, would depend on the potential contagion impact on the banking sector of the `run'.

Third, technology — by way of providing additional networked channels such as ATMs, phone banking and Internet banking — has significantly increased the speed, spread and impact of a withdrawal rush. This has greatly increased the complexity of the logistical issues of cash management and the need for banks to react faster to be able to minimise the impact of such events. Increasingly, banks that offer the facility to transfer of funds to other banks using technology-enabled channels, like Internet and phone banking, would need to keep additional liquidity in such situations. Banks need to be geared to collect currency from the currency chests located across the country and service their widely-dispersed ATMs and branches on a continuous and round the clock basis.

The rating agency has tried to estimate the magnitude of currency requirement of a bank in case of a `run'. A network of 100 ATMs, assuming each can store currency worth Rs. 12-15 lakhs and could need replenishment 7-9 times everyday, would require currency worth over Rs. 100 crores in a day. Over and above this, cash requirement at branches in the affected area would be a multiple of the currency requirement for an ATM. Hence, in Crisil's opinion, readiness and effectiveness of a crisis management plan would be a key determinant of a bank's ability to minimise impact of a run on its deposits.

Four, while the triggers for a sudden large-scale loss of depositor confidence are hard to predict, a regional run on a bank could quickly spread to other geographies due to availability of speedy means of communication that include electronic telecommunication and media. Banks need an internal risk management and communication mechanism that identifies a `run', and is able to communicate it to the senior management immediately. Then, a speedy and effective communication of the bank's financial and liquidity position is imperative to stem the loss of confidence and hence minimise the impact of the run. A public communication that the regulator (RBI) might make about the financial soundness of the affected bank and the support RBI is willing to provide to it is extremely effective in such situations.

Crisil believes that appropriate public statements by the top management of the bank through various mass electronic media are also equally important to boost depositor confidence. Further, banks need to have coherent strategies in place for confidence-building communication and depositor management through branch staff, some of whom may even be specifically trained to handle such situations.

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