Bank Run

What Is a Bank Run?

A bank run happens when a large number of customers of a bank or other financial institution pull out their deposits all the while over worries of the bank's solvency.

As additional individuals pull out their funds, the likelihood of default increases, prompting more individuals to pull out their deposits. In extreme cases, the bank's reserves may not be adequate to cover the withdrawals.

• A bank run happens when large gatherings of depositors pull out their money from banks at the same time founded on fears that the institution will become insolvent.
• With additional individuals withdrawing money, banks will go through their cash reserves and eventually wind up defaulting.
• Bank runs have happened since the beginning of time including during the Great Depression and the 2008-09 financial crisis.
• The Federal Deposit Insurance Corporation was laid out in 1933 in response to a bank run.
• Silent bank runs happen when funds are removed by means of electronic transfer instead of face to face.

Understanding Bank Runs

Bank runs happen when a large number of individuals begin making withdrawals from banks since they fear the institutions will run out of money. A bank run is regularly the consequence of panic as opposed to true insolvency. A bank run set off by fear that drives a bank into actual insolvency addresses a classic illustration of an inevitable outcome. The bank takes a chance with default, as individuals keeping withdrawing funds. So what begins as panic can eventually transform into a true default situation.

That is on the grounds that most banks don't keep that much cash close by in their branches. In fact, most institutions have a set limit to the amount they can store in their vaults each day. These limits are set in view of need and for security reasons. The Federal Reserve Bank additionally sets in-house cash limits for institutions. The money they in all actuality do have on the books is utilized to loan out to other people or is invested in various investment vehicles.

Since banks ordinarily keep just a small percentage of deposits as cash close by, they must increase their cash position to fulfill the withdrawal needs of their customers. One method a bank uses to increase cash close by is to sell off its assets — sometimes at essentially lower prices than if it didn't need to rapidly sell.

Losses on the sale of assets at lower prices can make a bank become insolvent. A bank panic happens when various banks get through runs simultaneously.

A History of Bank Runs

Bank runs return as soon as the coming of banking, when goldsmiths in Europe during the fifteenth and 16th hundreds of years would issue paper receipts redeemable for physical gold in excess of the stock that they held. This was an early illustration of fractional reserve banking, by which bankers could issue more paper notes redeemable for gold than they held in stock.

The concept was viable since the goldsmiths (and more modern bankers) realize that on some random day, just a small percentage of gold close by would be demanded for redemption. Notwithstanding, assuming depositors abruptly demanded their gold deposits at the same time, it could mean catastrophe — and this happened several times in response to poor harvests or political unrest.

In modern history, bank runs are frequently associated with the Great Depression. In the wake of the 1929 stock market crash, American depositors started to panic and look for asylum in holding physical cash. The primary bank disappointment due to mass withdrawals happened in 1930 in Tennessee. This seemingly minor and isolated incident, nonetheless, prodded a string of subsequent bank runs across the South and afterward the whole country as individuals heard what occurred and tried to pull out their own deposits before they lost their savings — a herding behavior that main accelerated more bank runs by means of a negative feedback loop.

Bits of gossip started to spread that banks were refusing to give customers back their cash, causing even greater panic and uneasiness among the public. In December 1930, a New Yorker who was educated by the Bank regarding United States against selling a specific stock left the branch and quickly started telling individuals the bank was unwilling or unable to sell his shares. Interpreting this as an indication of insolvency, bank customers lined up in large numbers and, within hours, pulled out more than $2 million from the bank.

The succession of bank runs that happened in the mid 1930s addressed a domino effect of sorts, as fresh insight about one bank disappointment frightened customers of neighboring banks, prompting them to pull out their money, where a single bank disappointment in Nashville prompted a large group of bank runs across the Southeast.

In response to the bank runs of the 1930s, the U.S. government set up several regulatory systems to prevent this from happening again, including establishing the Federal Deposit Insurance Corporation (FDIC), which today insures depositors up to $250,000 per banking institution.

The 2008-09 financial crisis was again met with some notable bank runs. On September 25, 2008, Washington Mutual (WaMu), the 6th largest American financial institution at that point, was closed down by the U.S. Office of Thrift Supervision. Throughout the ensuing days, depositors had removed more than $16.7 billion in deposits, causing the bank to run out of short-term cash reserves.

The exceptionally next day, Wachovia Bank was likewise covered for comparative reasons, when depositors pulled out more than $15 billion north of a fourteen day period after Wachovia reported negative earnings results before that quarter. A large part of the withdrawals at Wachovia were concentrated among commercial accounts with balances over the $100,000 limit insured by the Federal Deposit Insurance Corporation (FDIC), drawing those balances down to just below the FDIC limit.

Note, nonetheless, that the disappointment of large investment banks like Lehman Brothers, AIG, and Bear Stearns was not the consequence of a run on the bank by depositors. Rather, these came about because of a credit and liquidity crisis involving derivatives and asset-backed securities.

Preventing Bank Runs

In response to the strife of the 1930s, governments found a way several ways to diminish the risk of future bank runs. Maybe the greatest was establishing reserve requirements, which order that banks maintain a certain percentage of total deposits close by as cash.

Also, the U.S. Congress laid out the FDIC in 1933. Made in response to the many bank disappointments that occurred in the preceding years, this agency insures bank deposits. Its mission is to maintain stability and public confidence in the U.S. financial system.

Be that as it may, at times, banks need to adopt a more proactive strategy whenever confronted with the threat of a bank run. This is the way they might make it happen.

1. Slow it down. Banks might decide to close down for a while in the event that they are confronted with the threat of a bank run. This prevents individuals from lining up and pulling their money out. Franklin D. Roosevelt did this in 1933 after he assumed office. He declared a bank holiday, calling for inspections to guarantee banks' solvency so they could continue operating.

2. Borrow. Banks might borrow from different institutions in the event that they need more cash reserves. Large loans might stop them from going bankrupt.

3. Insure deposits. When individuals realize their deposits are insured by the government, their fear generally dies down. This has been the case since the U.S. laid out the FDIC.

Central banks normally act as a last resort for lending to individual banks during emergencies like a bank run.

Bank Run versus Silent Bank Run

Bank runs are normally portrayed as a long line of bank customers tensely waiting their chance to step up to the teller's window and demand their accounts be closed. Today, when a bank run happens, it isn't met with long lines. A purported silent bank run is when depositors pull out funds electronically in large volumes without physically entering the bank. Silent bank runs are like normal bank runs, aside from funds are removed by means of ACH transfers, wire transfers, and different methods that don't need physical withdrawals of cash.

Somehow or another, these new innovations make the prospect of a bank run even more threatening according to the point of view of a bank. Numerous traditional barriers that would have eased back the pace of a bank run —, for example, customers needing to stand by in long lines to pull out funds — are as of now not applicable. Essentially, customers today don't have to hold on to place orders within a bank's working hours. They can issue an order online and that order will be handled once the bank opens.
Then again, these modern comforts could likewise benefit banks by making the occurrence of a bank run less noticeable to outside eyewitnesses. A depositor may be bound to pull out their funds in the event that they see different depositors lining up outside a bank wishing to do as such. With electronic withdrawal demands, the side effects of a bank run might be less handily seen.

Often Asked Questions

What Is Meant by a Run on the Bank?

At the point when individuals in a real sense run as fast as possible to their bank in order to pull out their funds for fear of the bank collapsing is where the term originated. At the point when this is done all the while by numerous depositors, the bank can run out of cash to provide for their customers (due to fractional reserve banking) and subsequently collapse.

When Was the Last Bank Run?

The last reported bank run happened in May of 2019 when false tales spread over social media and messaging applications that U.K.- based MetroBank was trying to seize customers' assets and funds held in safe deposit boxes. Accordingly, MetroBank customers started demanding their money. Panic started to spread as photographs were posted on Twitter showing customers queueing to access their accounts.

Why Is a Bank Run Bad?

Bank runs make negative feedback loops that can bring down banks and cause a more systemic financial crisis. Since a bank may just have close by, express 10% of the cash addressed by overall deposits, if express 20% of customers demand their money back the bank essentially will not have sufficient close by to return to their depositors. If, be that as it may, the pace of withdrawals were to be staggered and spread out over the long run, the bank would most likely have the option to concoct the cash required.

Is a Bank Run Possible Today?

While there are several regulatory components now in place to relieve bank runs, silent bank runs mediated by electronic transfers can make a run on the bank still conceivable.