Fuel crisis? Some lessons from bank runs

Bank runs: a metaphor for petrol panic

The problem of panic buying is closely related to one that has been thoroughly studied in economics, namely bank runs. Bank runs are possible because banks hold less money (reserves) than the stock of demand deposits. Usually this is not a problem because, at each point in time, depositors only need to withdraw a small fraction of their savings for everyday needs. In fact, it would be a waste if banks kept all people's savings in their vaults rather than investing them in more productive ways.

But what if all depositors want to withdraw at once? With a bank unable to pay its customers, a crisis may ensue in which panic spreads to other banks and trust in the financial system wanes. This is essentially what happened in the City of London in 1866 after the collapse of Overend Gurney, while the Northern Rock crisis in 2007 – the UK’s first classic bank run in over 150 years – sent shockwaves through the financial system.

To understand how bank runs can be prevented, we need to place ourselves in the shoes of an individual depositor who sees others running to withdraw. What is his best response? If he does not go to the bank before the majority does, he will lose his savings, so his best response is to withdraw as soon as possible. But if all depositors behave like that, banks would indeed collapse. Of course, if nobody runs to withdraw, there would be no issue. But importantly, if you don't run and others do, you lose your money for sure!

This is the same dynamic we have seen with petrol: drivers in need of fuel have rationally followed their incentives to refuel early, but this has exacerbated the shortage, making it rational for others to join the forecourt frenzy.

Policy responses

So, how do you prevent people from running in the first place? Economists have suggested several remedies to bank runs, such as central banks as lender of last resort and deposit insurance (e.g. the Financial Services Compensation Scheme insures deposits up to £85,000 per person). Deposit insurance should prevent a run because, to the extent that individual savings are protected, each individual no longer has incentives to run even if others do. Their savings are safe so they will get their money either way. And the beauty is that, as a result, nobody will run in the first place. So, these policies can be cheap too.

Of course, deposit insurance must be carefully designed to minimize moral hazard – and it is crucial that the insurance scheme have a clear set of rules that are known to the public. The importance of clear communication of such ‘backstop’ policies can hardly be overstated; for instance, in the depth of the Eurozone debt crisis, Mario Draghi’s “whatever it takes” speech sent a clear signal that helped to calm the bond markets, even before any policy actions were actually implemented (see here and here).

The UK government’s communication in the petrol crisis fell short on several fronts. By initially denying any role for the Army, the government tried to minimize the issue and send out the message ‘don’t panic’. But the message it in fact sent was that policymakers were not on top of the situation and prepared to do “whatever it takes”. Given the poor communication and contingency planning of the government, it is not surprising that consumers, unsure of the true situation, responded by panic buying.

It is not possible to prevent runs on essential goods altogether. But when a run does occur, we would advise against the government telling people that, should they panic buy, there will not be enough petrol. Telling people not to panic buy or else we will run out, tells them to panic indeed! What is needed in a run is policies that will restore trust, rather than ‘talk but no plan’. The government eventually realized this and put the Army on standby ready for deployment, but by this time much damage had already been done.

The way forward

In the short term the lack of lorry drivers is given. Thus, a best response for the government could be to formalize arrangements with the Army along the lines of deposit insurance. This could take the form of a contingency plan which states that, should a substantial bottleneck in supply occur, Army support will be triggered on an immediate basis. Ideally, this ‘insurance scheme’ should be widely known to the public. The logic is simple: if people know that a shortage will trigger more petrol coming to stations almost immediately, then precautionary buying is unnecessary and so demand should stay close to normal levels.

The above suggestion is very different to the government’s actual response. Because Army deployment was unplanned, the impact on supply was delayed and did not lower expectations of petrol shortage. Moreover, a ‘wait and see’ approach is highly risky because in uncertain circumstances people want to feel as if they are doing something proactive to take charge of the situation – which in this case meant buying more petrol. Note that bringing in the Army unexpectedly could make the situation worse (at least initially), as people may infer that the problem is severe and respond by panic buying.

The government’s long-term response should focus on recruiting and retaining lorry drivers. Reforms to working conditions could help attract more domestic workers, but it seems likely that more overseas workers will be needed – at least in the medium term. The UK government’s plans for extra short-term visas will not meet this long-term challenge. With wise long-term policies, instead, the ‘deposit insurance’ provided by the Army could eventually be removed.

Alessandro Mennuni, University of Southampton

Michael Hatcher, University of Southampton