What Is a Bank Run?
A bank run occurs when a large number of customers of a bank or other financial institution withdraw their deposits simultaneously over concerns about the bank's solvency.
As more people withdraw their funds, the probability of default increases, prompting more people to withdraw their deposits. In extreme cases, the bank's reserves may not be sufficient to cover the withdrawals.
Understanding Bank Runs
Bank runs happen when a large number of people start making withdrawals from banks because they fear the institutions will run out of money. A bank run is typically the result of panic rather than true insolvency. A bank run triggered by fear that pushes a bank into actual insolvency represents a classic example of a self-fulfilling prophecy. The bank does risk default, as individuals keeping withdrawing funds. So what begins as panic can eventually turn into a true default situation.
That's because most banks don't keep that much cash on hand in their branches. In fact, most institutions have a set limit to how much they can store in their vaults each day. These limits are set based on need and for security reasons. The Federal Reserve Bank also sets in-house cash limits for institutions. The money they do have on the books is used to loan out to others or is invested in different investment vehicles.
Because banks typically keep only a small percentage of deposits as cash on hand, they must increase their cash position to meet the withdrawal demands of their customers. 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 the sale of assets at lower prices can cause a bank to become insolvent. A bank panic occurs when multiple banks endure runs at the same time.
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