"Now people have the ability to transfer money instantly, but FUD (Fear, Uncertainty, and Doubt) – pushed by social media and rapid communication, will, at some point, create runs on banks in a click of a mouse or at the touch of a screen… the Fed needs to force banks to increase reserves, now."
Over the past seven years I have speaking and publishing thoughts on the movement to a more digital form of global payment rails, namely cryptocurrency. During that period, we have seen the blockchain innovation push government and private companies into evolving money. One such outgrowth in the US was the creation of FedNow in 2019, and now released recently. It is a big move for the Fed, and while they dismiss it, it is very likely a movement in the general direction of a CBDC (Central Bank Digital Currency). Technology innovation pushed the US Federal Government into greater alignment with the likes of Venmo, CashApp, PayPal, and Zelle. This is step one on a long path toward the true digitization of money.
As background, FedNow is a real-time payments rail that enables instant payments for businesses operating in the United States. It is available to depository institutions in the United States and allows individuals and businesses to send instant payments through their depository institution accounts.
What is my concern?
In March 2023 a small but significant banking crisis occurred with the failure of Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank, all failing within five days. In my research and interviews with the bank heads, they each expressed bewilderment at the speed that funds were withdrawn from their banks. Once news was released that each bank was in trouble, billions of dollars were transferred by depositors in seconds to hours. Time to transfer money has decreased substantially, which is a double-edged sword. We all want our money instantly, and over the years this has become closer to reality. People can gain access to their assets and have them transferred much faster than in recent times.
The concern that I have with FedNow is that institutions large and small can now immediately transfer funds out, likely creating bank runs far faster than ever. In other words, people now have the ability to transfer money instantly, but FUD (Fear, Uncertainty, and Doubt) – pushed by social media and rapid communication, will, at some point, create runs on banks in a click of a mouse or at the touch of a screen.
Responding to prevent potential global contagion might be far more difficult.
Recommendation
The Fed is moving in the right direction with granting depositor’s instant transfers to and fro their bank, but they must require banks to increase their reserve!
The commonly assumed reserve requirement for banks is 10%, though no major central bank imposes such a ratio requirement. Banks can meet this requirement with vault cash and balances in their Federal Reserve accounts, but because neither of these assets earns interest, banks have an incentive to minimize their holdings.
Banks have historically been required to keep a small stash of cash, typically between 3 and 10 percent of their deposits, on hand – this is no longer enough.
In an age when people instantly get information, and make decisions (perhaps rash) almost as quickly, the potential for bank runs with FedNow is much higher than it was before. In some ways, the model of waiting 5-7 days for some transfers actually slowed the potential for this problem. Ultimately, as instant has finally become the path forward, banks should now hold far greater reserves to protect themselves from a run, which could fuel the next regional or global bank contagion. The future of true banking – holding crypto assets, CBDC, cash – will likely be an almost one-to-one reserve, to protect against this, as it is the fiscally conservative path forward.