A run on the bank is the vernacular expression for a bank run. Runs on the banks actually happen as a result of many bank customers deciding to take out their deposits at one time. They do this out of fear that the bank is either broke or on its way to becoming insolvent. When runs on the banks get started, they have a tendency to create their own terrible momentum that leads to a self fulfilling prophecy. The more customers who take out their money, the greater the odds of bank default become, which leads to still more customer deposit withdrawals. If this happens long enough, it will likely upset a bank’s finances to the point that the bank encounters bankruptcy as a result.
Runs on the bank can often lead to bank panics. These financial crises result from a large number of banks experiencing bank runs all at once. If the bank panics are not dealt with swiftly and convincingly, then a systemic banking crisis can develop. In such a banking crisis that is system wide, it is not uncommon to witness practically all, or even all, of a country’s banking capital disappear.
Once this occurs, numerous bankruptcies follow, many times ending up in a deep and painful economic recession or even depression. Bank runs created a great amount of the economic damage that you saw done in the Great Depression. Associated costs of fixing the mess related to a systemic banking crisis are enormous. Over the last forty years, these expenses around the world have averaged fully thirteen percent of the respective countries’ Gross Domestic Products in fiscal costs, leading to losses of economic output that averaged twenty percent of Gross Domestic Product.
Runs on the bank are able to be prevented with a few different strategies. Withdrawals can be suspended. More effectively, deposit insurance systems can be put in place, like the one that the Federal Deposit Insurance Corporation operates in the United States. The Central Bank may also help out banks by performing the function of the lender of last resort in times of banking crises. Such strategies are commonly effective, but not always. Even when countries possess deposit insurance, the bank depositors could still be fearful that they will not have instant access to their bank held deposits while the bank is reorganized by the FDIC.
The reason that runs on the bank are able to happen in the first place is because of the fractional reserve banking system. Modern day banks only keep a small percentage of their demand deposits in cash on hand, typically ten percent in developed nations. The rest of these deposits are tied up in loans that have longer terms than demand deposits. This leads to a mismatch of assets and liabilities. Though some banks keep better reserves than others do, no modern bank keeps sufficient reserves in its vaults to handle the majority of their deposits being withdrawn at a single time.