Question

What is a bank run?

Short answer

A bank run occurs when a large number of customers try to withdraw their money from a bank simultaneously due to fear or loss of confidence in the bank's solvency. It can be triggered by financial panic, economic crisis, or bank failure and may result in insolvency, financial contagion, and economic contraction. To prevent and manage bank runs, governments and central banks implement measures such as deposit insurance, acting as a lender of last resort, and enforcing regulatory capital requirements.

Step-by-step solution

Definition of a Bank Run

A bank run, also known as a run on the bank, occurs when a large number of customers try to withdraw their money from a bank at the same time. This sudden demand for withdrawal is typically fueled by fear or loss of confidence in the bank's solvency and the ability to protect their deposits.

Causes of a Bank Run

Bank runs can be triggered by various factors, including: 1. Financial Panic: Rumors or genuine concerns about a bank's financial health can lead to loss of confidence among depositors, prompting them to withdraw their funds. 2. Economic Crisis: During an economic downturn, depositors may try to access their savings due to financial hardship, or out of fear that the bank may collapse. 3. Bank Failure: If a large bank fails, depositors of other banks could panic and initiate runs on their own banks, even if these institutions remain solvent.

Consequence and Impact of a Bank Run

Bank runs can have severe consequences for both the bank and the economy: 1. Insolvency of the Bank: When a large number of customers withdraw their deposits, the bank may experience liquidity problems and become unable to meet its financial obligations, leading to insolvency, and possible bankruptcy. 2. Financial Contagion: Bank runs can spread to other banks and financial institutions as depositors fear for their savings. This may lead to widespread failures in the banking system and potentially a financial crisis. 3. Economic Contraction: As banks face liquidity pressures and increase their credit risk, they might reduce or halt lending activities, leading to reduced investments and economic growth, and possibly contributing to a recession.

Prevention and Regulation

Governments and central banks have implemented various measures to prevent and manage bank runs, such as: 1. Deposit Insurance: Governments use deposit insurance schemes to protect depositors' savings up to a specific limit, reducing the fear of losing money and, thus, discouraging bank runs. 2. Lender of Last Resort: Central banks may act as a lender of last resort by providing emergency liquidity to banks facing a run, ensuring they can meet their depositors' withdrawal demands. 3. Regulatory Capital Requirements: Governments enforce capital and liquidity requirements on banks to ensure they hold a sufficient buffer to absorb financial shocks and remain solvent during crisis periods.