A bank run occurs when customers of a bank or financial institution simultaneously decide to withdraw all their deposited funds. This phenomenon is typically triggered by concerns about the bank’s financial stability. The process often escalates rapidly, akin to a snowball effect. As more individuals retrieve their money, the likelihood of the bank defaulting increases, prompting even more customers to withdraw their deposits. Severe bank runs can lead to a situation where the institution’s reserves are insufficient to meet all withdrawal demands.
Most bank runs are not initiated by actual insolvency but rather by widespread panic which can eventually cause the feared insolvency as more clients withdraw their money. What begins as rumor and panic can ultimately result in a genuine insolvency scenario, demonstrating how the fear of default can actually precipitate a default in the banking sector.
Banks are particularly vulnerable to these situations because they typically maintain only a small fraction of their total deposits as readily available cash. When faced with escalating withdrawal demands, banks are forced to increase their liquid reserves. A common strategy to achieve this is by selling assets, often at significantly reduced prices due to the urgent need for funds. The losses incurred from these fire sales can potentially lead to actual insolvency.
A bank run can become a full-scale bank panic when multiple banks experience simultaneous runs. The best known example of this occurred in the aftermath of the 1929 stock market crash, which led to numerous runs on banks across the United States and ultimately contributed to the Great Depression. The cascade of bank runs in late 1929 and early 1930 created a domino effect, where the failure of one bank sparked fear and panic among customers of neighboring banks, motivating them to withdraw their deposits as well.
During the Great Depression, some bank runs were initiated by rumors spread by individual bank clients. For instance, in December 1930, a New York customer of the Bank of United States was advised against selling a particular stock. Upon leaving the branch, he informed other customers and individuals that the bank was unable or unwilling to sell his shares. This led to a misinterpretation that the bank was insolvent, resulting in thousands of clients withdrawing over $2 million from the bank within hours.
In response to the chaos of the 1930s, governments of developed nations implemented a series of measures to mitigate the risk of future bank runs. One of the most effective strategies involved establishing minimum bank reserve requirements, which dictated the percentage of total deposits banks must keep readily available in cash.
Additionally, in 1933, the U.S. Congress created the Federal Deposit Insurance Corporation (FDIC) as a direct response to the numerous bank failures. This government agency has since insured bank deposits up to a maximum account amount, working to maintain public confidence and stability within the United States financial system.
