What Is a Bank Run? - How Bank Runs Happen ?

A bank run occurs when a large number of customers of a bank or other financial institution withdraw their deposits simultaneously on fears that the bank will become insolvent. Bank runs happen when a large number of people start making withdrawals from banks because they fear the institutions will run out of money. A bank run is typically the result of panic rather than true insolvency. As more people withdraw their funds, the probability of default increases, prompting more people to withdraw their deposits. In extreme cases, the bank's reserves may not be sufficient to cover the withdrawals. With more people withdrawing money, banks will use up their cash reserves and ultimately end up defaulting. the clients keep the cash or transfer it into other assets, such as government bonds, precious metals or gemstones. When they transfer funds to another institution, it may be characterized as a capital flight. As a bank run progresses, it generates its own momentum: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals. This can destabilize the bank to the point where it runs out of cash and thus faces sudden bankruptcy.To combat a bank run, a bank may limit how much cash each customer may withdraw, suspend withdrawals altogether, or promptly acquire more cash from other banks or from the central bank, besides other measures. A banking panic or bank panic is a financial crisis that occurs when many banks suffer runs at the same time, as people suddenly try to convert their threatened deposits into cash or try to get out of their domestic banking system altogether. A systemic banking crisis is one where all or almost all of the banking capital in a country is wiped out.The resulting chain of bankruptcies can cause a long economic recession as domestic businesses and consumers are starved of capital as the domestic banking system shuts down.According to former U.S. Federal Reserve chairman Ben Bernanke, the Great Depression was caused by the Federal Reserve System, and much of the economic damage was caused directly by bank runs.The cost of cleaning up a systemic banking crisis can be huge, with fiscal costs averaging 13% of GDP and economic output losses averaging 20% of GDP for important crises from 1970 to 2007. Several techniques have been used to try to prevent bank runs or mitigate their effects. They have included a higher reserve requirement (requiring banks to keep more of their reserves as cash), government bailouts of banks, supervision and regulation of commercial banks, the organization of central banks that act as a lender of last resort, the protection of deposit insurance systems such as the U.S. Federal Deposit Insurance Corporation, and after a run has started, a temporary suspension of withdrawals.These techniques do not always work: for example, even with deposit insurance, depositors may still be motivated by beliefs they may lack immediate access to deposits during a bank reorganization. A bank run triggered by fear that pushes a bank into actual insolvency represents a classic example of a self-fulfilling prophecy. The bank does risk default, as individuals keeping withdrawing funds. So what begins as panic can eventually turn into a true default situation. That's because most banks don't keep that much cash on hand in their branches. In fact, most institutions have a set limit to how much they can store in their vaults each day. These limits are set based on need and for security reasons. The Federal Reserve Bank also sets in-house cash limits for institutions. The money they do have on the books is used to loan out to others or is invested in different investment vehicles. Because banks typically keep only a small percentage of deposits as cash on hand, they must increase their cash position to meet the withdrawal demands of their customers. One method a bank uses to increase cash on hand is to sell off its assets—sometimes at significantly lower prices than if it did not have to sell quickly. Losses on the sale of assets at lower prices can cause a bank to become insolvent. A bank panic occurs when multiple banks endure runs at the same time. The stock market crash of 1929 precipitated a spate of bank runs across the country, ultimately culminating in the Great Depression. The succession of bank runs that occurred in late 1929 and early 1930 represented a domino effect of sorts, as news of one bank failure spooked customers of nearby banks, prompting them to withdraw their money. For example, a single bank failure in Nashville led to a host of bank runs across the Southeast. Other bank runs during the Depression occurred because of rumors started by individual customers. In December 1930, a New Yorker who was advised by the Bank of United States against selling a particular stock left the branch and promptly began telling people the bank was unwilling or unable to sell his shares. Interpreting this as a sign of insolvency, bank customers lined up by the thousands and, within hours, withdrew over $2 million from the bank. An uncontrolled bank run can result in a bank's bankruptcy or when multiple banks are involved, a banking panic, which at its worst can lead to an economic recession. A bank may try to avoid the negative effects of a bank run by limiting the amount of cash a customer can withdraw at one time, temporarily suspending withdrawals altogether, or borrowing cash from other banks or the central banks to cover the demand. Today, there are other provisions to protect against bank runs and bankruptcy. For instance, the reserve requirements for banks have generally increased and central banks have been organized to provide quick loans as a last resort. Perhaps most important has been the establishment of deposit insurance programs such as the Federal Deposit Insurance Corporation (FDIC), which was set up during the Great Depression in response to the bank failures that exacerbated the economic crisis. Its aim was to maintain stability in the banking system and to encourage a certain level of confidence and trust. The insurance remains in place today.








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