Bank run
A Bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may fail in the near future. In other words, it is when, in a fractional-reserve banking system (where banks normally only keep a small proportion of their assets as cash), numerous customers withdraw cash from deposit accounts with a financial institution at the same time because they believe that the financial institution is, or might become, insolvent. When they transfer funds to another institution, it may be characterized as a capital flight. As a bank run progresses, it may become a self-fulfilling prophecy: 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 acquire more cash from other banks or from the central bank, or limit the amount of cash customers may withdraw, either by imposing a hard limit or by scheduling quick deliveries of cash, encouraging high-return term deposits to reduce on-demand withdrawals or suspending withdrawals altogether.
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 failure of the Federal Reserve System to prevent deflation, 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 is when a large number of depositors, fearing a bank’s insolvency, simultaneously rush to withdraw their money. This panicked, large-scale withdrawal can deplete the bank’s available cash reserves, potentially causing a financial crisis even if the bank is fundamentally healthy.
The potential for a bank run exists because of the fractional reserve banking system, in which banks lend out most of the money they take in and keep only a fraction on hand as cash. The system depends on customer confidence that their money is safe.
How a bank run starts A bank run can be triggered by a number of factors, which can spread quickly in the digital age through social media.
- Loss of confidence: Rumors, news reports, or social media speculation about a bank’s financial health can ignite fear among depositors.
- Economic downturns: Broader financial instability, such as a recession or market crash, can lead to a general loss of trust in the banking system.
- Contagion effect: The failure of one bank can cause a domino effect, leading customers of other banks to fear for their own deposits.
- Sudden liquidity needs: A large number of customers withdrawing cash for a specific reason, like an economic crisis, can create a sudden demand for funds.
The effects of a bank run When a bank run occurs, a destructive feedback loop begins, with potential consequences for both the bank and the broader economy.
- Liquidity crisis: The bank may be forced to quickly sell its assets, potentially at a loss, to meet withdrawal demands.
- Bank failure: If the bank cannot raise enough cash, it can become insolvent and be taken over by regulators.
- Wider financial panic: A bank run can cause a contagion effect, spreading fear and potentially sparking runs on other banks and contributing to a financial crisis.
- Economic recession: A widespread banking panic can disrupt the financial system and contribute to an economic recession.
How bank runs are prevented Governments and regulators have put measures in place to build confidence and prevent bank runs.
- Deposit insurance: Agencies like the Federal Deposit Insurance Corporation (FDIC) in the U.S. insure customer deposits up to a certain amount (currently $250,000). This removes the incentive for most depositors to withdraw their money during a crisis.
- Lender of last resort: Central banks, such as the Federal Reserve, can provide emergency loans to banks to ensure they have enough liquidity to meet withdrawal demands.
- Capital requirements: Regulations like the Basel III agreement require banks to hold a certain amount of capital in reserve to improve their ability to withstand financial shocks.
- Regulatory oversight: Bank regulators monitor the health of financial institutions to detect problems early.
AI responses may include mistakes.
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