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A bank run occurs when depositors withdraw their funds, causing insolvency for the bank. This can lead to a financial crisis known as a bank panic. Fractional reserve banking and investments can exacerbate the situation. Measures such as the FDIC can mitigate the effects, but customers should be aware of their rights.
A bank run is a situation where depositors panic and simultaneously withdraw their deposits from a banking institution. The result of the massive drain on the bank’s resources is usually insolvency for the bank, ironically creating a situation where a panic about insolvency creates insolvency. When multiple bank runs occur at the same time, the result can be a widespread financial crisis known as a bank panic. Banking panics played a prominent role in numerous financial crises, such as the Great Depression in the United States.
The process leading to bank foreclosure is usually gradual. First, the economy begins to slow, making consumers uneasy. Then consumers begin to fear that their deposited funds are unsafe and consider withdrawing those funds and placing them elsewhere or withdrawing them from circulation altogether. As panic mounts and consumers become increasingly stressed, they turn to a bank in a huge group to demand their funds on deposit.
Banks, however, do not hold all the funds they have on deposit. Most banks use a system known as fractional reserve banking, in which a percentage of general deposits are kept on hand, while the bulk of deposited funds are invested in various ways. This practice allows banks to make money. When enough bank customers arrive to demand their funds, a bank can run out of funds and become insolvent.
As a bank struggles to meet consumer demands in a bank run, it may solicit loans, bonds and other investments, causing a ripple effect. Debtors can become insolvent as a result of a bank transaction, as can companies associated with the bank’s investments. When a bank fails as a result of a bank run, it can also spur more panic and uncertainty, causing a bank panic.
Many countries have measures in place that are designed to mitigate the effects of bank runs. In the United States, for example, the Federal Deposit Insurance Corporation (FDIC) guarantees deposits of up to $100,000, which means that even if a bank becomes insolvent, the bank’s customers still get their money back. For customers with an excess of $100,000 on deposit, however, a bank run creates the risk of losing those additional funds, which can devastate savings and retirement accounts.
During a financial panic, it’s important for bank customers to keep their heads. Anyone who has funds deposited with a financially distressed institution has certain rights as a consumer. These rights are usually outlined in the flyers the bank provides when someone opens an account, and customers can also contact agencies such as the FDIC or the equivalent for more information.
Asset Smart.
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