When Borrowers Flee First

Banking shocks are a recurring threat to economic stability, as past financial crises demonstrate. The academic literature has mainly studied bank runs as a cause of bank failures, thus focusing on banks' struggles regarding liability and funding. However, much less is known about the initial stages of banking crises and the dynamics leading up to the collapse of financial institutions.

In "Corporate Runs and Credit Reallocation," we focus precisely on the initial period of banking stress and in particular on the dynamics regarding assets, analyzing the behavior of corporate clients. They play a crucial role in this process as they can accelerate a bank's deterioration not only because their deposits are not typically covered by deposit insurance, but also because they simultaneously borrow from the same bank.

It is the best clients who leave, in fact, as they are the ones worried about the solvency of the struggling bank. High value-added firms, which depend on credit lines for access to liquidity, tend to diversify their sources of financing, establishing new credit relationships with stronger institutions. Because the best and most reliable firms are the ones most likely to obtain alternative financing, stressed banks find themselves having to manage a portfolio of riskier borrowers with greater credit constraints. This process can further exacerbate any banking crisis, leading to a progressive deterioration of assets and amplifying the risk of a bank run by depositors. In essence, our paper highlights a new dimension of banking crises: "credit-line runs," similar to depositor bank runs. 

Our analysis uses data from the Bank of Italy and the experience of the failure of two Italian regional banks, but our results have a much broader scope. In fact, recent academic work has shown that most bank failures in the US since 1850 are characterized by a slow deterioration in asset quality and the flight of depositors not covered by deposit insurance.

Our work has important implications for the management of banking crises.

First, in non-systemic banking crises — such as the March 2023 crisis in the US — our findings suggest that market forces tend to drive a reallocation of credit that further weakens the assets of distressed banks. These results therefore highlight the need for timely intervention by banking supervisors and regulators. In line with recent debates over the failures of Credit Suisse and Silicon Valley Bank, regulators should closely monitor market signals — including on social media — and respond quickly.

Second, the study highlights an often-overlooked role of bank capital. In addition to acting as a buffer against losses and aligning incentives, bank capital is critical to ensuring that market-driven reallocation of deposits and credits takes place efficiently. The results show that the most solid and productive firms are able to move to better-capitalized banks, while the weaker ones face greater financing constraints. This selective process, based on the soundness of bank capital, helps ensure that credit continues to flow to the firms best suited to support investment and economic growth.

In addition, the paper suggests that banking regulation needs to consider not only the behaviour of banks, but also that of firms in times of crisis. Rapid interventions, such as liquidity injections from central banks and clear communication to avoid panic, can reduce the risk of runs and limit financial contagion.