Substantively, banks are pooled investment funds, like mutual funds, exchange traded funds, and so on: They take people’s money and use it to buy financial assets. There is one crucial difference, however. In those other funds, losses are immediately passed on to investors. But that is not true with banks, because a bank’s depositors can completely avoid its losses by nimbly taking their money out before the bank fails. This is sort of an absurd feature; imagine being able to avoid a mutual fund’s losses by simply taking your money out before others do, as in a game of musical chairs.
Further, people sometimes interpret the lack of information about banks as ominous. Thus, the solution is for banks to issue daily reports of financial metrics, like the amount of their deposits. That way, stakeholders would be assured that if something were going on at the bank, they would have immediate notice and the ability to withdraw their money.
Mutual funds report daily financial metrics, such as their net asset value, as do almost all other types of investment vehicles. Yet a bank’s depositors need those daily updates at least as much as a mutual fund’s investors do. So why are banks exempt from daily disclosure?
If banks do not become more transparent with their stakeholders by reporting such daily metrics, four things will continue to happen:
Unable to figure out which banks are on solid footing, stakeholders will be suspicious of all regional banks.
Depositors will look for other signs of a bank’s health, such as its stock price, whose high volatility due to a lack of current information will be unsettling.
Some banks will attempt to fool depositors, exacerbating mistrust. For example, First Republic issued a misleadingly rosy March 16 press release that failed to disclose deposit outflows. When the bank was forced to disclose those outflows on April 24 in its quarterly earnings report, it undermined confidence in its executives to the point where all stakeholders fled, causing the bank to fail. On May 5, PacWest Bancorp issued a press release declaring its “sound” health but failing to disclose a 10 percent loss in deposits the prior week. When it was finally forced to report that loss in its May 11 quarterly filing, the bank’s stock fell 23 percent.
Rather than wait months for the next call report or earnings release to resolve this uncertainty, depositors will abandon regional banks, even if in some cases the bank is healthy.
Adding to the reams of existing bank regulations won’t solve the problem, and neither will better training of bank examiners, who are already widely suspected of being vulnerable to industry capture.
The best solution to this and future banking crises is forthright and continuous disclosure of financial metrics, so that stakeholders (depositors and shareholders) can figure out which banks are truly healthy and worth their support.
This post comes to us from Alireza Gharagozlou, a retired attorney and actuary who is studying the efficient market hypothesis.