The Dynamics of Deposit Flightiness and its Impact on Financial Stability

We find that the flightiness of depositors displays pronounced fluctuations over time, reaching unprecedentedly high levels after the Covid-19 crisis. Elevated deposit flightiness coincides with expansions in central bank reserves and low interest rate environments. We rationalize these trends based on heterogeneity in investors’ convenience value for deposits. In our dynamic model, investors in the banking system value the convenience benefits of deposits more than those that choose to invest in non-banks. Following deposit inflows from outside investors, e.g., due to QE’s reserve expansions, the marginal depositor in the banking system becomes more rate-sensitive and the risk of panic runs increases. Our findings imply that the risk of panic runs triggered by policy rate hikes is amplified when the Fed’s balance sheet size is larger, highlighting a novel linkage between conventional and unconventional monetary policy.