Bank Run Definition
A bank run (also known as a run on the bank) occurs when a large number of customers of a bank or another financial institution withdraw their deposits simultaneously over concerns of the bank’s solvency.
Bank Run: Key Points
- A bank run happens when many customers withdraw their money simultaneously.
- It is usually triggered by panic or a fear that the bank will be insolvent.
- Bank runs can destabilize the banking system leading to an economic crisis.
- Banks usually only keep a small fraction of their total deposits as cash, due to the fractional reserve banking system, which makes them vulnerable to bank runs.
- Central banks usually act as a lender of last resort to prevent bank runs.
What is a Bank Run?
A bank run is a financial crisis that occurs when many of a bank’s customers try to withdraw their deposits at the same time. Such mass withdrawals occur because customers fear that the bank might become insolvent in the near future and will not be able to return their deposits.
Why do Bank Runs Happen?
Bank runs usually happen in response to an unexpected financial crisis or rumour about a bank’s insolvency. Even if the bank is actually solvent, a bank run can cause the bank to become bankrupt. This is because banks generally do not hold 100% of depositors’ money, but lend it out in the form of loans to earn interest. This is known as the fractional reserve banking system.
How does a Bank Run Work?
During a bank run, a large number of customers queue up to withdraw their deposits. Because banks typically only have a fraction of deposits as cash on hand, it is difficult for them to fulfill all withdrawal requests. The bank might be forced to sell off its assets hastily at a loss, in order to fulfill its obligations and this could lead to insolvency.
When do Bank Runs Occur?
A bank run typically happens in an unstable economic environment when panic or rumours about the financial stability of a bank or banking system start to spread. The fear that their deposits could be lost if the bank fails, leads customers to withdraw their funds as quickly as possible.
Effects of a Bank Run
A bank run can lead to a widespread economic crisis, as it can contribute to the failure of a single bank or a cluster of banks. This can cause a domino effect, where the failure of one bank prompts a run on other banks – a situation that can destabilize the entire banking system and can lead to a recession.
Handling a Bank Run
The central bank of a country usually steps in when there’s a risk of a bank run. It acts as the lender of last resort, providing the necessary liquidity to the troubled bank in hopes of assuaging depositors’ fears. In some cases, the government also offers deposit insurance to protect depositors’ funds and to prevent panic withdrawals.
