Bank Runs Mean Bank Alternatives Are Rising

As the financial world weighs how and whether the runs on Silicon Valley Bank and Signature Bank could affect other banks and the rest of the economy, the Lynde and Harry Bradley Foundation is announcing John Cochrane as one of this year’s winners of the $250,000 Bradley Prize.

What excellent timing. Cochrane has been writing for more than a decade at, among other places, his “Grumpy Economist” blog, about the problems of banking and the Federal Reserve as currently structured, and about the potential of alternatives.

In 2012 Cochrane suggested breaking up the Fed to separate monetary policy and financial regulation. He warned, “our society is not built on faith in the wisdom of an unaccountable aristocracy with huge power and no supervision. That will be even more disastrous. That's where the Fed is going, and it cannot last.”

In 2014, in a post headlined “Toward a run-free financial system,” he flagged a book chapter he wrote proposing steps that would reduce the risks of runs. Also in 2014, he had a post about nonbank lenders rising as alternatives to banks.

Perhaps one reason the markets overall have so far mostly shrugged off the bank runs of 2023 is that, as Cochrane has been suggesting, banks are less irreplaceable than they used to be.

This is true not only for lending and borrowing but for holding money. Axios reports that some of the money running from banks is flowing into money market mutual funds.

Some of this is technology enabled, as apps, algorithms, and websites fill the roles once played by banker and branches. Customers can finance retail purchases with Affirm, send and receive payments with Venmo (owned by Paypal), and get a home mortgage with Rocket Mortgage.

Some of it is competing firms or even government agencies chipping away at various bank specialties. Businesses can borrow from Cerberus Business Finance or Ares. Small-scale real-estate operators, such as home flippers, can look to “hard money lenders.”

Auto buyers can get loans from Toyota Financial Services or from other auto-makers’ equivalents. Families borrowing to finance higher education now largely turn to direct loans from the federal government rather than from banks.

Walmart, which is not a bank, has in-store centers that provide banklike services including check-cashing, billpaying, installment financing, sending and receiving money, and sending money to Mexico.

Even loans between family members are replacing banks. The Wall Street Journal reported on people “borrowing from family members instead of a bank.” It cited a company called National Family Mortgage, whose chief executive says the firm “has closed more than $1 billion in intrafamily loans since 2010, with default rates of less than 1%.”

All in all, there just aren’t that many remaining lines of business for which banks are the only possible providers. Cash management, perhaps. But that just makes the case for “narrow” banking, in which banks focus on their core competencies of counting money and keeping it safe and accessible to depositors.

It may be that some banks can find ways to add value for customers, particularly with bankers who bring deep relationships and expertise. Just because there are competing nonbank firms doesn’t mean that banks need to surrender or retreat from entire market sectors.

The traditional tradeoff has been that banks get federal insurance and liquidity in exchange for federal regulation. If that turns out to be more of an encumbrance than an advantage, more and more of the work of banking will be pushed outside banks to other institutions.

When those alternative institutions hit unexpected trouble, as some of them almost certainly eventually will, their customers or owners or both will descend on Washington pleading for help, just the way bankers and bank depositors do.

The politicians and bureaucrats will want to listen and weigh the appropriate response. As they do, though, they will want to remember that competition and innovation and failure and risk are all parts of the free enterprise system.

Markets have a way of rising spontaneously to fill unmet needs and resolve problems, not always perfectly but better than most central planners, and with more wisdom and long-term success than the “unaccountable aristocracy with huge power.”