BANK RUNS IN THE DIGITAL ERA: TECHNOLOGY, PSYCHOLOGY, AND REGULATION

A bank run occurs when a large group of depositors withdraw their money from banks at the same time. The bank customers involved are typically driven by fears that the institution will become insolvent. As more people withdraw money, banks use up their cash reserves and can end up in default. In late 2022 and early 2023, a number of banks experienced deposit runs that were extraordinarily fast and large by historical standards even though numerous protective mechanisms, such as deposit insurance, had been put in place. At the same time, the banking industry was undergoing substantial technological advances that were not accompanied by a considerable change in regulations, resulting in more frequent and faster bank runs. To explain these unprecedented developments, this Article points to three factors related to advances in technology and the rise of digital banking that can affect the probability of bank runs: 1. The time effect—Changes in technology have enabled faster withdrawals, and social media has facilitated the rapid dissemination of information. 2. The coordination effect—Social media enables coordination among depositors and solves the coordination problem demonstrated in the seminal Diamond-Dybvig model (1983). 3. The psychological effect—Changes in technology reduce psychological friction points, leading to higher rates of withdrawal. Using empirical and experimental evidence, as well as game theory, this Article analyzes the role these factors play in bank runs in the digital era and develops policy implications. In addition, this Article critically analyzes one of the most historically popular solutions to bank runs—namely bailout—and offers a coherent solution that includes nudging withdrawal decisions using technology, and especially artificial intelligence (“AI”), as a psychological friction mechanism.