What is a Bank Run
A bank run occurs when a large number of customers of a bank or another financial institution withdraw their deposits simultaneously due to concerns about the bank's solvency. As more people withdraw their funds, the probability of default increases, thereby prompting more people to withdraw their deposits. In extreme cases, the bank's reserves may not be sufficient to cover the withdrawals.
BREAKING DOWN Bank Run
A bank run is typically the result of panic rather than true insolvency on the part of the bank. However, the bank does risk default as more individuals withdraw funds; what began as panic can turn into a true default situation. A bank run triggered by fear that pushes a bank into actual insolvency represents a classic example of a self-fulfilling prophecy.
How Bank Runs Happen
Because banks typically keep only a small percentage of deposits as cash on hand, they must increase cash to meet depositors' withdrawal demands. 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 selling the assets at lower prices can cause a bank to become insolvent. A bank panic occurs when multiple banks endure runs at the same time.
Bank Run Examples
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 and prompted 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 as a result of rumors started by individual customers. In December 1930, a New Yorker who had been 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.
Preventing Bank Runs
In response to the turmoil of the 1930s, governments took several steps to diminish the risk of future bank runs. Perhaps the biggest was establishing reserve requirements, which mandate that banks maintain a certain percentage of total deposits on hand as cash.
Additionally, the U.S. Congress established the Federal Deposit Insurance Corp. (FDIC) in 1933. Created in response to the many bank failures that happened in the preceding years, this agency insures bank deposits. Its mission is to maintain stability and public confidence in the U.S. financial system.