What to do if there is

On April 7 we woke to the news that Qantas and Velocity were limiting the volume and the way loyalty points can be redeemed for rewards, in order to conserve cash in these times without revenue from flying.

At the same time we find that Australians are withdrawing so much cash from banks that the Reserve Bank had to make special arrangements to supply enough currency. And don’t talk to me about toilet paper and hand sanitiser!

Are all of these phenomena examples of the same behaviour that we associate with ‘runs’ on banks in the Great Depression and more recently in the GFC?

“A bank run occurs when a large number of customers of a bank or other financial institution withdraw their deposits simultaneously over concerns of the bank’s solvency.”  https://www.investopedia.com/terms/b/bankrun.asp

Feels like irrational behaviour by a lot of people, but economists, notably the Nobel Laureate John Nash (“A Beautiful Mind” subject) tell us it is not. The “Nash equilibrium” model helps explain runs like those we have experienced recently. Faced with two strategy choices, panic buy or act normally, equilibrium is achieved by everyone acting normally or everyone panic buying (or you will have no toilet paper).

Having just converted all my frequent flyer points to gift cards, I can identify with the panic equilibrium personally. Feels safer.

Banks are vulnerable because they employ Fractional Reserve Banking. They take your deposits, put a small percentage aside and invest the rest with other customers to make a profit. The Fractional Reserve meets their cash withdrawal needs in normal times, but if there is a run, they cannot meet the demand and may not be able to sell the investment quickly enough to satisfy customers.

Loyalty programs tend to operate in a similar fashion. Member’s points are like a bank deposit, with a promise to return the value when the member requests. Program operators may not actually keep this obligation to pay in the future 100% covered with cash reserves. They keep enough to cover normal reward volumes and put the balance to profitable use elsewhere.

If members are concerned that their program may not survive the current crisis then there may be a run on the currency in order to preserve their accumulated value (members see points as having a cash value). In normal times, the frequent flyer programs have an owner, the airline, who is still generating revenue that can be used to meet the increased demands of members, but with both Australian airlines effectively grounded this source of funds is limited. If members fear the airline itself may not survive, the impetus for a run increases.

The other large-scale programs in Australia are operated by retailers who continue to trade, in fact grocers and pharmacies are thriving because of the other runs. We would not expect the same member fervour for rewards in those programs currently. There will be some increase however as members unsure of the future of work will conserve their cash by spending points first.

There have been runs like this before, especially on banks, so what lessons have been learned that can be applied to these programs to help revert to an equilibrium where there are no shortages, and everyone acts normally? How do you stop a run?

Slow it down

This is exactly what the 2 frequent flyer programs in Australia have done. Limit choice and limit volume. Two of each item only and one gift card per day are examples of restrictions introduced this week. In extreme cases close redemptions all together for a period to slow the impetus down, though we shudder to think what this would do to trust levels in members. During the Depression, US banks would clog the teller queues with staff and family to slow the withdrawal process; long wait times on the rewards phone line would only be partially effective in the IOT era.

Get access to additional funds

If the concerns about survival disappear, so should the run.

The high demand for cash from Australian banks has abated since the Government announced massive stimulus and job retention financial packages for the economy.

Both airlines have publicly canvassed a government loan to help weather the travel ban periods. No joy so far.

There is a precedent for another approach; the bulk sale of points to ‘wholesalers’ like American Express, Banks, Woolworths… organisations that buy points from the frequent flyer program to reward their customers. US bank point wholesalers, injected billions of dollars into airline coffers in the last industry downturn by pre-buying points. Could we see a similar action here? The airlines grumble now about the discounts they had to give in order to close these deals, but we all have poor memories of pain.

Insure member’s point value

This is the equivalent of the government deposit guarantee, introduced in Australia during the GFC and in America during the Great Depression. The government guarantees that people will get their money back if the bank fails.

No obvious moves by the airlines’ programs in this direction; the program’s terms & conditions follow – though I received an email from Velocity today, April 14, reminding me “…Velocity is set up in a way that safeguards member value by having a trustee that looks after the interests of members.”

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The best solution to this (suspected) run on two of our largest loyalty programs is to all safely get through this lock down successfully and get the travel business back to previous activity levels.