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What Is a Bank Run Definition Examples and How It Works

What Is a Bank Run Definition Examples and How It Works

Maddy Simpson, an experienced data journalist and fact-checker with a background in financial analytics, explains what a bank run is. It occurs when customers of a bank or financial institution withdraw their deposits at the same time due to concerns about the bank’s solvency. This can lead to a higher probability of default and more people withdrawing their deposits. In extreme cases, the bank may not have enough reserves to cover the withdrawals.

Key Takeaways:

– A bank run happens when a large group of depositors withdraw their money from banks simultaneously.

– Customers withdraw money in bank runs out of fear that the institution will become insolvent.

– As more people withdraw money, banks deplete their cash reserves and can go into default.

– Bank runs have occurred in significant historical events such as the Great Depression and the 2008 financial crisis.

– The Federal Deposit Insurance Corporation (FDIC) was established in 1933 to reduce the frequency of bank runs.

How Bank Runs Work:

Bank runs occur when many people make withdrawals because they fear the bank will run out of money. These are typically caused by panic rather than actual insolvency. However, a bank run triggered by fear can push a bank into bankruptcy.

Most banks have daily limits on how much they keep in their vaults for security reasons. They also hold specific amounts in reserve at the central bank to minimize the risks associated with bank runs. The Federal Reserve incentivizes banks to keep deposits in reserve through its Interest on Reserve Balances (IORB) program.

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Since banks typically keep only a small percentage of deposits as cash on hand, they need to increase their cash position to meet withdrawal demands. One method banks use is selling assets at lower prices, which can cause customer concerns and trigger more withdrawals.

Examples of Bank Runs:

Bank runs are often associated with significant events like the Great Depression. After the 1929 stock market crash, American depositors started withdrawing their deposits, leading to a series of bank runs in the early 1930s.

More recent examples of bank runs include Silicon Valley Bank, Washington Mutual Bank (WaMu), and Wachovia Bank.

Silicon Valley Bank experienced a bank run in March 2023, triggered by venture capitalists. The bank reported a need for $2.25 billion to strengthen its balance sheet, and customers withdrew approximately $42 billion within a day. The bank eventually closed, and its assets were taken over by regulators.

Washington Mutual (WaMu) had about $310 billion in assets when it failed in 2008. Factors contributing to its collapse included a weak housing market and rapid expansion. Within two weeks, customers withdrew $16.7 billion, and JPMorgan Chase subsequently acquired the bank.

Wachovia Bank also experienced a bank run when depositors withdrew over $15 billion after negative earnings results. The bank was eventually acquired by Wells Fargo for $15 billion. The majority of these withdrawals came from commercial accounts with balances above the insured limit by the FDIC.

Unlike bank runs, the failures of investment banks like Lehman Brothers, AIG, and Bear Stearns were a result of credit and liquidity crises, involving derivatives, asset-backed securities, and poor risk management.

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Preventing Bank Runs:

Governments implemented measures to reduce the risk of bank runs after the 1930s. One significant step was the establishment of reserve requirements, mandating that banks maintain a percentage of total deposits as cash. The Federal Reserve has since reduced this requirement to zero, as other monetary policy tools have been implemented.

Additionally, the U.S. Congress established the FDIC in 1933 to insure bank deposits and maintain stability in the financial system. The FDIC provides insurance based on ownership categories. Typically, each depositor is insured for up to $250,000 in each category, and the FDIC may extend coverage in specific cases.

In some cases, banks need to take proactive measures when facing a bank run threat, such as temporary closures or implementing bank holidays for inspections. Franklin D. Roosevelt implemented a bank holiday in 1933 to ensure banks’ solvency, allowing them to continue operating.

Silent Bank Runs:

Silent bank runs are similar to regular bank runs, but depositors withdraw funds electronically through methods like ACH transfers and wire transfers, without physically entering the bank.

Run on the Bank:

A run on the bank occurs when people attempt to withdraw all their funds due to fears of a bank collapse. When many depositors withdraw simultaneously, the bank can run out of cash and become insolvent.

Why Bank Runs Are Bad:

Bank runs can lead to the collapse of banks and cause systemic financial crises. Banks typically don’t hold enough cash to fulfill all withdrawal demands, resulting in insufficient funds for depositors.

In conclusion, a bank run happens when customers rapidly withdraw their deposits due to concerns about the bank’s solvency. This can lead to default and the potential collapse of the institution. Governments have implemented measures like reserve requirements and the FDIC to prevent bank runs, but they can still be disruptive to the financial system.

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