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What Is Bank Run? Definition, Reasons, Examples

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by Ibukun Ogundare · 7 min read
What Is Bank Run? Definition, Reasons, Examples
Photo: Unsplash

The guide below will explore the reasons for the chaotic time for banks known as bank runs, as well as explain how such a situation can be prevented.

There are many uncertainties regarding using centralized financial firms like commercial banks, hedge funds, and insurance companies, to mention a few. In search of trust in the financial world, people settle for institutions with indispensable records over the years. Potential bank customers do not only evaluate key features like account types, home loans, interest rates, certificates of deposit, insurance, and financial planning services. They also look out for the total net worth of the firm, year-on-year profits, and perhaps many other reliable partnering companies.

Though prospective customers carry out research on the stability of banks before conducting business with them, this research does not prevent future funds management. Sometimes, external financial crises or investment mishaps affect a financial institution’s solvency in a way that is beyond the management’s control. What could be the outcome of leadership gone wrong? Would anyone still keep their hopes high when a financial institution is going red? Any small mistake in financial management could cost a lot to any financial institution. This guide will cover a common reaction of large depositors and retail customers whenever a financial institution is on the verge of becoming insolvent. This is what we call a bank run. Most times, large depositors and retail customers move their funds out of the crippling bank to a safer financial institution or hold their net worth in cash. These figures are sometimes converted or used to purchase financial derivatives like gold and silver.

Bank Run Defined

A bank run is a financial chaos where many customers withdraw their funds from a financial institution. The customers may physically run to the bank or move their funds online. This chaos is often triggered by factors signifying an impending collapse of the institution involved. Factors may include end-of-the-year financial reports, monthly financial statements, leaked internal memos, change of management, or even the failure of partnering sister companies. To put it simply, a bank run means running to a bank to save your asset from perishing.

As a result of fear, several other customers run to the bank to withdraw their funds. In severe cases, fund withdrawals go beyond the bank’s available cash at hand.

What Happens During a Bank Run?

During a bank run, a large number of customers flock to the bank to get their funds out of their accounts. In most scenarios, bank runs result from panic against true insolvency. The high demand for withdrawals often caused by fear can potentially push the bank into actual insolvency. For most banks, a limited amount of cash is available for daily withdrawals as it is obligated to keep cash on hand in a private vault or a central bank account. However, spikes in cash withdrawals strain and exhaust the bank’s cash threshold. At this stage, these financial institutions seek cash from other banks or the central bank to settle the financial overdrain. On some accounts, banks sell off their assets at a lower price to cushion the explosion in cash withdrawals.

Reasons for a Bank Run

Fear is the major cause of bank runs. Factors like financial reports, internal memos, failed investments, and the collapse of partnering firms, among many others, often trigger this feeling. Once a bank experiences a noticeable decline in share prices or profit, customers take turns withdrawing from their accounts. Commercial banks, large firms, and venture capitalists often spearhead bank runs. The distrust in the banking system of the affected financial institutions pushes many retail customers to panic, resulting in a bank run.

Silent Bank Run

A silent bank run is one where customers withdraw their funds without visiting the bank physically. In this modern banking system, many customers opt for a silent bank run where they initiate transactions via ACH transfers (bank-to-bank transfers), wire transfers, and other non-physical withdrawal methods. Through this method, banks do not need to long for cash whenever a bank run occurs. However, the effect on the crippling bank is the same.

Examples of Bank Runs

Bank runs originated from the Great Depression, which occurred from 1929–1939. Many individuals mitigated the increasing bank losses on deposits by taking refuge in holding cash. The Global Financial Crisis (GFC) of 2008 exposed more financial institutions to bank runs. Since 2008, over 500 banks have collapsed due to bank runs. Here are a few examples of bank runs event:

  • Silicon Valley Bank. This bank run is the second-largest in history. The bank initially announced a deficit of over $2.5 billion during its financial reports in March 2023. After the news, venture capitalists withdrew over $42 billion before the end of the business day, causing regulators to close the bank and take over its assets. Before this incident, SVB announced an asset of $209 billion in Q4 2022. After striking a deal with FDIC, First Citizens acquired the failed Silicon Valley Bank for approximately $72 billion.
  • The collapse of Washington Mutual (WaMu) is unarguably the biggest bank run of all time, losing over $310 billion. WaMu was forced to fold up due to factors accompanying the 2008 GFC, like the poor housing market and rapid expansion. The bank experienced a two-week run where customers withdrew over $16.7 billion. American multinational financial company JP Morgan Chase (NYSE: JPM) purchased Washington Mutual for $1.9 billion.
  • Wachovia Bank collapsed after the firm announced negative earnings results. Subsequently, customers withdrew over $15 billion within two weeks. Unfortunately, the majority of Wachovia Bank’s customers were commercial banks with account balances above the $250,000 FDIC insurance limit. Wells Fargo bought Wachovia Bank for a sum of $15 billion.
  • During the Great Depression in 1930, two banks experienced bank runs resulting from rumors. These rumors pulled down many other commercial banks into bank runs. Tennessee Hermitage National Bank of Nashville, Tennessee, was responsible for the bank run of 120 banks after failing to disburse cash to hundreds of customers. Similarly, a man spread rumors of banks failing to sell shares after the Bank of the United States declined his request to sell off all his bank shares. His rumors made over 2,500 customers withdraw over $2 million within a day.

Prevention of Bank Runs

There are several ways of preventing bank runs. In most cases, bank runs are illusions of a bank’s insolvency. Therefore, if a bank implements mitigating measures at the beginning of the crisis, bank runs can be kept at bay.

A bank can slow down or delay transactions to prevent bank runs. It could be a limited withdrawal amount or failed transactional activities. In this modern world of digital banking, technical issues are deliberately in place to prevent online transactions from being completed. This measure allows the financial firm to access short-term liquidity, and raise and satisfy demands.

As earlier stated, banks can reach out to other banks or the central bank to borrow some cash. If the bank gets a large amount of loan from any sister firm, it could prevent the risk of going bankrupt. Insurance deposit is another fundamental preventive measure against bank collapse.

Through insurance deposits, customers are well assured that their funds will be reimbursed to the insured amount if the bank goes bankrupt. For every depositor in a registered bank, the US Federal Deposit Insurance Corporation (FDIC) provides insurance of $250,000.

Ultimately, banks can sort for non-callable term deposits where deposits can only be withdrawn after an agreed time. The customer’s deposit would be returned with an accrued interest. Term deposit helps the bank escape bankruptcy even if other withdrawals are made.

Final Thoughts

Generally, prospective bank customers are looking for a financial firm that can provide stability, trust, and transparency. Therefore, customers must be cautious of banks without insurance or even questionable financial reports. They can also ensure that their deposits are below the insurance limit. From time to time, financial institutions close up due to fund mismanagement or external factors. In most cases, the factors behind the bank’s failure are beyond its capacity.

Most importantly, not all bank collapse is caused by bank runs. Bank collapse of large investment banks like Lehman Brothers, AIG, and Bear Stearns was caused by a credit and liquidity crisis.

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FAQ

What is a bank run?

A bank run is a situation where many customers visit a bank to withdraw their deposit. It is often triggered by speculations of an impending bankruptcy accompanied by fear and panic. This results in the outflow of large chunks of money within a short period. 

What happens during a bank run?

When bank runs happen, the bank experiences a spike in withdrawals against the regular occurrence. During this chaos, the bank runs out of cash to settle the outrageous withdrawal amount. 

Why does a bank run occur?

A bank run occurs due to financial mismanagement or loss experienced by a bank. Customers stop banking with financial banks after discovering unpleasant financial reports, implicating sanctions, or leaked internal memos.

What is a silent bank run?

A silent bank run is a situation where customers withdraw funds from their bank accounts via ACH transfers (bank-to-bank transfers), wire transfers, and other non-physical withdrawal methods. Banks are not pressured to get more cash when this situation occurs. 

Is it possible to prevent a bank run?

Yes, bank runs can be prevented using strategic measures. Banks can deliberately delay fund disbursement by shutting down temporarily or disabling online transactions. The management can borrow loans from other banks or the central bank. Other preventions include deposit insurance and non-callable term deposit. 

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