Bank Run
What is Bank Run?
A bank run is a sudden mass withdrawal of deposits by customers who fear a bank will fail, which can push a solvent bank into failure.
Banks promise depositors their money on demand but hold most of it as loans and other assets that cannot be sold quickly at full value. That mismatch is profitable in normal times and fatal when many depositors want cash at once. Because a failing bank pays out first come, first served, withdrawing early is the sensible move for anyone who expects others to withdraw, so the belief that a run is coming can produce one. The distinction that matters is between illiquidity and insolvency: an illiquid bank holds good assets it cannot sell fast enough, while an insolvent bank owes more than its assets are worth. A run can turn the first condition into the second, which is why central banks lend against collateral and governments insure deposits.
Bank Run: a worked example
A bank holds $10 million of reserves and $95 million of loans against $100 million of deposits, so its equity is $105 million minus $100 million, or $5 million, and it is solvent. Depositors then demand $30 million back. The bank pays $10 million from reserves and must raise the other $20 million by selling loans, but a rushed sale fetches only 70 cents on the dollar, so it has to sell $28.6 million of face value. It is left with $66.4 million of loans against $70 million of remaining deposits, so its equity is now negative $3.6 million. The run itself made the bank insolvent.
The mistake students make with bank run
Students assume a run only hits banks that were already failing, and that the bank ran out of money because it lost the money. The cash was never sitting in a vault; it was lent out, and those loans can be perfectly sound but slow to sell. A run is a timing problem first, which is why a bank that is solvent on paper can still be destroyed by one.
Bank Run questions
Can a bank run happen to a healthy bank?
Yes, a run can destroy a bank whose assets are worth more than its debts, because the problem is how fast those assets turn into cash, not whether they are good. Once withdrawals exceed reserves the bank must sell at rushed prices, and losses on those sales can wipe out equity that was adequate the day before.
What is the difference between a bank run and a bank panic?
A bank run is withdrawals at one bank, while a bank panic is runs spreading across many banks at the same time. Panics spread because depositors cannot tell which banks are weak, so bad news about one institution makes them pull deposits from others as a precaution.
How do governments stop bank runs?
Governments stop runs mainly with deposit insurance, which pays covered depositors whether or not they got in line early, so the reason to rush disappears. Central banks add a lender-of-last-resort facility that lends against collateral to a bank that is solvent but short of cash, and supervisors can close and resolve a failed bank quickly so depositors keep access to their money.
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