Jens Weidmann, the renowned German economist and president of the Deutsche Bundesbank, has warned that crypto currencies like bitcoin have the potential to make financial crises in the future even more devastating.
Speaking in Frankfurt this week, Jens Weidmann said he believes that central banks will eventually create their own digital currencies to reassure average citizens that such currencies are safe and stable, but in doing so could increase the risk of bank runs in future crises.
“This is a feature which will become relevant especially in times of crisis – when there will be a strong incentive for money holders to switch bank deposits into the official digital currency simply at the push of a button. But what might be a boon for savers in search of safety might be a bane for banks, as this makes a bank run potentially even easier.”
Jens Weidmann‘s basic point is that by making currencies fully digital in future, withdrawing money from a bank would become much more simple. Instead of physically having to visit a cashpoint or bank branch to withdraw cash, customers could do it online or using their mobile wallets.
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In times of crisis, when people tend to take money out of their accounts so they can have the perceived safety of cash, causing the phenomenon of the bank run.
WHAT IS BANK RUN
A bank run occurs when customers lose faith in the stability of the bank and the safety of their money, so decide to take out their cash. This, in turn, makes the bank’s problems even worse, because they lose cash liquidity, making it more difficult for them to fulfil their obligations.
A bank run occurs when in a banking system (banks normally only keep a small proportion of their assets as cash), a large number of customers withdraw cash from deposit accounts with a financial institution at the same time because they believe that the financial institution is, or might become, insolvent; and keep the cash or transfer it into other assets, such as government bonds, precious metals or gemstones.
When they transfer funds to another institution it may be characterised as a capital flight. As a bank run progresses, it generates its own momentum: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals.
This can destabilize the bank to the point where it runs out of cash and thus faces sudden bankruptcy. To combat a bank run, a bank may limit how much cash each customer may withdraw, suspend withdrawals altogether, or promptly acquire more cash from other banks or from the central bank, besides other measures.
BANK RUN DURING GREAT DEPRESSION
During the great depression in 1929-30, wealthy people were taking their investment assets out of the economy, and consumers overall were spending less money. Bankruptcies were becoming very common, and peoples’ confidence in financial institutions such as banks was being rapidly eroded. Some 650 banks failed in 1929; the number would rise to more than 1,300 the following year.
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