How to stop Greece’s “bank jog”

by Mohamed El-Erian

Financial Times
May 28, 2012

Bank runs are not supposed to happen in a modern advanced economy. Yet, newspapers reported last week that Greek depositors were stepping up their withdrawal of savings held in local banks. Understanding why this is happening – and what we can do about it – is key to assessing the threat to European and global growth, jobs and financial stability.

There are two critical safeguards against the start and disorderly acceleration of bank runs: national deposit insurances schemes and central bank provision of emergency liquidity. They kick in once the banking system’s first line of defence – which consists of strong capital and good assets on the balance sheet – is breached.

Many banks were caught offside by the global financial crisis and the widespread economic and financial deterioration that followed. The result was a sharp erosion – both real and perceived – in capital cushions relative to the quality and size of the assets. Moreover, given the heavy concentration of government bonds on banks’ balance sheets, the situation took a further and significant turn for the worse with the downgrading of sovereign creditworthiness in some European countries, and most prominently in Greece.

More