A bank run is an event that happens when a bank or financial institution’s customers choose to withdraw all of their deposits at the same time. This happens because of fears of the solvency of a particular bank. The effect is like a snowball. The more individuals who pull out their funds the greater the default probability becomes. This in turn leads still other customers to pull out their deposits. Severe bank run cases can create a scenario where the reserves of the bank are insufficient to meet all withdrawal demands.
Bank runs like these are not usually a result of actual insolvency of a financial institution. Rather they occur because of panic. Such fear can still evolve into a self fulfilling prophecy as a greater number of clients request their money. What starts as rumor and panic can transform into an actual ugly insolvency scenario. This means the fear of a default can actually cause a default in banking circles.
Banks run into these troubling situations sometimes because they generally only hold a tiny percentage of their actual deposits at hand. When withdrawal demands rise, it forces banks to boost their cash reserves. A common method for doing this is to sell assets, often at fire sale prices because they need funds immediately. The losses banks book for selling off assets at greatly reduced prices can lead them to actual insolvency. A bank run can become a full scale bank panic when a number of banks experience such runs on them all at once.
The best known example of a bank run occurred surrounding the infamous stock market crash in 1929. This led to numerous runs on financial institutions throughout the United States and finally to the Great Depression. The cascade of runs on the banks in the end of 1929 and the beginning of 1930 became like dominos falling. One bank’s failure created fear and caused the panic of customers at neighboring banks that motivated them to take out their deposits as well. A failing bank in Nashville at the time created a number of bank runs throughout the Southeastern U.S.
Still other runs on banks occurred in the Great Depression because of the rumors begun by individual clients of the banks. The Bank of United States told a New York customer in December of 1930 he should not sell a certain stock he held. He departed from the branch and told other customers and individuals that the bank could not or would not sell his stock shares. Clients of the bank thought this meant the bank was insolvent. Thousands of them then lined up and withdrew more than $2 million out of the bank in only hours.
The developed nations’ governments enacted a serious of steps to decrease the possibilities for future date bank runs as a result of the chaos in the 1930s. The most effective centered on minimum bank reserve requirements. These dictated what percent of aggregate deposits banks had to keep readily available in cash.
In 1933, the American Congress also created the FDIC Federal Deposit Insurance Corporation. They established it as a direct result of the numerous bank failures. The government agency has since then insured deposits in banks to a maximum account amount. It works to keep up public confidence and banking stability within the financial system of the United States.