A Simple Way To Prevent Bank Runs
By Evan Miller
February 5, 2011
The Federal Deposit Insurance Corporation promises to insure a bank's depositors against that bank's failure. It is commonly believed to prevent bank runs.
There is a much simpler way to prevent bank runs without government involvement. Banks should do away with demand deposits, whereby you are entitled to get your money back at any time. As Jimmy Stewart cogently explains, your money is not at the bank:
For savings accounts, demand deposits should be replaced with fixed-term deposits (1 year, 2 years, etc.). If you need your money before your deposit has matured, you simply trade your certificate of deposit that matures in the future for a certificate of deposit that matures today. Each bank should operate a market for deposits on its website, and allow anyone to participate. If you go to the bank, you'd see a big board with market rates like at a currency exchange, and be able to get cash today at the prevailing rate (trading in some of the fixed-term deposits you have with the bank).
Checking accounts rarely bear interest and so are (probably) immune to bank runs. However, with a liquid market for deposits, they could easily be merged into savings accounts. Writing a check simply converts your savings to cash at the going rate. ATMs in that case would be a front-end to the cash market.
When a strong demand for cash arises, there will be no possibility of banks failing, because each bank knows in advance how many deposits it must cash out on a given day. In response to increased demand for cash, the only result will be a higher price for cash on the open market that day.
Problem solved.