What is a Bank Run and how does it affect banks and the economy?

Bank runs are back in the news. Which may be a sign that big economic problems are coming. This time the victim is Silicon Valley Bank, which is based in Santa Clara, California. According to news reports, SVB Financial Group is exploring a sale after selling off billions of dollars in assets to make its clients whole and sparking a panic on Wall Street this week.

UPDATE: On March 10, 2023, SVB failed after a run on its deposits.The California Department of Financial Protection and Innovation (DFPI), its regulator, seized the bank and placed it into the receivership of the FDIC in the second-largest bank failure in U.S. history.

To better understand what's going on, let's take a look at what a run on the bank is and why it usually leads to bankruptcy.

What is a run on the bank

A bank run is a situation in which a large number of depositors simultaneously withdraw their funds from a bank or financial institution, often due to concerns about the solvency or stability of the bank. Bank runs can be triggered by a variety of factors, including rumors, news, or other events that cause depositors to lose confidence in the institution's ability to meet its obligations.

In a bank run, the sudden and significant withdrawal of funds can quickly deplete a bank's reserves, leaving it unable to meet the demands of all its depositors. This can lead to a cascade of more withdrawals and a downward spiral in the bank's financial health. If the bank is unable to meet its obligations, it may be forced to declare bankruptcy, which would cause significant losses for depositors and could have broader implications for the financial system as a whole.

To prevent bank runs, many countries have established deposit insurance schemes that protect depositors up to a certain amount if the bank fails. In addition, central banks can provide emergency liquidity to banks to help them meet their obligations in times of financial stress.

Here is a list of some notable bank runs that have occurred around the world over time:

  • Panic of 1907 (United States): The Panic of 1907 was a financial crisis that led to a widespread bank run in the United States. The crisis was triggered by an unsuccessful attempt to corner the market in United Copper Company shares, leading to a chain reaction of bankruptcies and bankruptcies at banks and other financial institutions.
  • The Northern Rock Bank Run (UK): The Northern Rock Bank Run occurred in 2007 when the bank faced a liquidity crisis due to its heavy reliance on wholesale funding markets. The bank had to be nationalized by the UK government to avoid systemic risk to the country's financial system.
  • IndyMac bank run (United States): IndyMac was a mortgage lender that went bankrupt during the 2007-2008 subprime mortgage crisis. The bank run on IndyMac occurred in July 2008, after the bank was placed under federal control due to its high-risk lending practices and deteriorating financial condition.
  • Run on the Creditanstalt (Austria): The run on the Creditanstalt occurred in 1931 during the Great Depression. Creditanstalt was one of the largest banks in Austria and its failure had major repercussions throughout the European banking system.
  • Diamond Bank Run (Nigeria): The Diamond Bank run occurred in 2006 when rumors spread that the bank was experiencing financial difficulties. The bank had to issue a statement assuring its clients that it was financially sound in order to quell the panic.
  • Banking collapse at Banco Popular (Spain): In June 2017, Banco Popular, one of the largest banks in Spain, faced a bank run after news reports suggested the bank was facing serious liquidity crisis. The bank was finally acquired by Banco Santander for the symbolic price of 1 euro.
  • Bank Foreclosure at Banco Ambrosiano (Italy): Banco Ambrosiano was an Italian bank that failed in 1982 after a series of financial scandals. The bank run on Banco Ambrosiano was triggered by the arrest of its president, Roberto Calvi, who was later found dead under mysterious circumstances.
  • Great Depression Bank Runs (United States): The Great Depression of the 1930s led to widespread bank runs in the United States as banks failed and depositors lost confidence in the banking system.
  • Bank Foreclosure at Bank of Credit and Commerce International (BCCI) (UK): BCCI was a bank that collapsed in 1991 following allegations of fraud and money laundering. The bank run on BCCI came after regulators seized the bank's assets and froze its accounts.
  • Continental Illinois (United States): Continental Illinois was a bank that collapsed in 1984 after suffering heavy losses on risky loans. The bank run on Continental Illinois was sparked by news reports of the bank's financial problems, leading to a rapid depletion of its deposits. The bank was eventually bailed out by the United States government.

The 2008 Financial Crisis and the WaMu Bank Run

The Washington Mutual (WaMu) bank run was a major bank run that occurred during the global financial crisis in 2008. Washington Mutual was the largest savings and loan association in the United States and had a presence significant in the mortgage loan market. In September 2008, concerns about the bank's solvency began to mount due to the increasing number of mortgage defaults and foreclosures in the US housing market.

On September 15, 2008, Lehman Brothers, a major investment bank, filed for bankruptcy, further fueling concerns about the stability of the US financial system. The next day, rumors began to circulate that Washington Mutual was on the brink of collapse. News reports suggested the bank was facing a liquidity crisis and that the Federal Deposit Insurance Corporation (FDIC) had been called in to oversee its operations.

These rumors triggered a massive bank run on Washington Mutual, with depositors lining up to withdraw their funds. Branches of the bank across the country were inundated with customers trying to withdraw their money, leading to long lines and chaotic scenes. Many customers withdrew their deposits in excess of the $100,000 FDIC-insured limit, resulting in significant losses for some depositors.

Despite efforts by the FDIC and other regulators to calm fears and reassure depositors, the run on the bank continued to escalate and on September 25, 2008, the FDIC seized Washington Mutual and its assets were sold to JP Morgan Chase for $ 1.9 billion. This marked the largest bank failure in US history at the time, with more than $307 billion in assets and $188 billion in deposits. The Washington Mutual bank run was a significant event in the financial crisis and highlighted the fragility of the banking system and the potential for panic and contagion during periods of crisis.

Effects on the economy

The consequences of a bank run and bank failure can be significant and have a wide-ranging impact on the economy. Some of the common consequences of a bank run and bank failure include:

  • Loses to depositors: A bank run can cause significant losses to depositors who are unable to withdraw their funds before the bank fails. Depositors can lose some or all of their savings, which can have a devastating impact on their financial well-being.
  • Contagion: A bank failure can trigger a contagion effect in which customers of other banks panic and withdraw their funds as well. This may lead to a broader crisis in the financial system, with the potential for multiple bank failures and significant disruption to the economy.
  • Credit crunch: Bank failures can cause a credit crunch, as banks become more cautious about lending and reduce their risk exposure. This can have a significant impact on businesses and consumers that rely on credit to finance their operations and investments.
  • Economic recession: A banking crisis can lead to a recession as credit crunch, and loss of confidence in the financial system can cause a decline in economic activity, leading to lower investment, employment and production.
  • Government intervention: In many cases, the government may need to intervene to support failing banks and prevent a broader crisis. This may include the provision of liquidity support, bank bailouts, and other measures to stabilize the financial system.

In general, the consequences of a bank run and bank failure can be severe and long lasting. They can erode confidence in the financial system, reduce access to credit, and cause major economic disruption. As such, it is essential that banks and regulators take steps to prevent such events and ensure the stability and resilience of the financial system.

How Governments Respond to a Bank Run

Governments can respond to bank runs in various ways to try to mitigate their effects and prevent the collapse of the banking system. Here are some common responses:

  • Central bank liquidity provision: The central bank may provide liquidity to affected banks to meet depositor demand for withdrawals and prevent the run on banks from spreading to other banks.
  • Government Deposit Insurance: The government may guarantee deposits up to a certain amount to reassure depositors and prevent them from withdrawing their funds.
  • Temporary Bank Closure: The government may temporarily close affected banks to stop the run and restore confidence. During this period, the bank may be restructured, recapitalized, or sold to another bank.
  • Capital injection: The government can inject capital into affected banks to strengthen their balance sheets and restore confidence.
  • Bailouts: The government can provide financial assistance to affected banks to avoid bankruptcy and avert a broader financial crisis.
  • Bank resolution: If the bank is insolvent, the government can intervene to resolve the bank's failure in an orderly manner to minimize disruption to the financial system.
  • Bank mergers and acquisitions: The government may facilitate the merger or acquisition of affected banks with stronger banks to avoid bankruptcy and maintain financial stability.

In general, the response of governments to bank runs can vary depending on the severity of the situation, economic and financial conditions, and the current regulatory and institutional frameworks. The objective is to prevent the spread of the bank run, maintain financial stability and protect the interests of depositors.

How do people react to these events?

Public reaction to government assistance in bank runs and bank failures can vary depending on the circumstances and the level of confidence in the government's ability to handle the situation. Here are some common ways the public can react to government help in these situations:

  • Relief: If government intervention succeeds in stabilizing the situation and protecting depositors, many people may feel relieved and grateful for the government's help.
  • Skepticism: Some people may be skeptical about the government's ability to handle the situation and may question the motives behind the intervention, especially if it involves taxpayer money or appears to favor certain banks or groups.
  • Disgust: If government intervention fails to prevent bank collapse or results in losses for depositors, some people may become angry and demand government accountability and transparency.
  • Calls for reform: Bank runs and bank failures can highlight weaknesses in the financial system and regulatory framework, leading to calls for reform and strengthening of the system.
  • Reduced trust: If government intervention is perceived as inadequate or ineffective, it can erode public trust in government and the financial system, which can have long-term consequences.

In general, the public's reaction to government assistance in bank runs and bank failures depends on the effectiveness of the intervention, transparency in communication, and the perceived motives and trustworthiness of the government. It is essential that policymakers communicate clearly and transparently and take action to restore confidence in the financial system and the government's ability to manage it.

Conspiracy Theories Associated With Bank Runs

Bank runs and bank failures can be complex and disturbing events, and can give rise to various conspiracy theories, rumors, and speculation. Here are some common conspiracy theories that can arise in the context of these events:

  • The government designed the bank's failure: Some people may speculate that the government intentionally designed the bank's failure to achieve certain political or economic goals.
  • Banks are manipulating the situation: Some people may speculate that banks are manipulating the situation to take advantage of the crisis or to consolidate their market power.
  • The news media is hiding the truth: Some people may believe that the media is not reporting the whole truth about the situation and is withholding critical information from the public.
  • The crisis is part of a larger global conspiracy: Some people may believe that the bank's failure is part of a larger global conspiracy involving powerful corporations, governments or secret societies.
  • Crisis is the prelude to a bigger disaster: Some people may speculate that the bank's failure is the prelude to a bigger disaster, such as an economic collapse or a world war.

In general, the conspiracy theories that arise in the context of bank runs and bank failures can be diverse and often reflect broader societal anxieties and suspicions. While some may be unsubstantiated or unsubstantiated, others may highlight genuine concerns about the workings of the financial system and the role of governments and corporations in running it.

These things happen

Bank runs and bank failures can be frightening and unsettling events, but it is important to remember that these events are relatively rare and that the financial system is designed to be resilient and withstand shocks. Most banks and financial institutions are well capitalized and regulated, and deposit insurance protects most depositors from loss.

The government and regulatory authorities have several safeguards in place to prevent and manage bank runs and bank failures, such as deposit insurance, lender-of-last-resort facilities, and capital adequacy requirements. These safeguards help prevent systemic risks and promote financial stability.

It is also important to provide context and perspective on the historical and economic significance of bank runs and bank failures. While these events can be disruptive and unsettling, the financial system has experienced and survived numerous crises in the past, and the economy and financial markets tend to recover over time.

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