Before the introduction of banks, people stored their money in places they considered safe. But the introduction of banks brought about a modernized, safe, and perhaps, profitable way to store money. Of course, while banks appear to be a haven for our money, people often fear what we call a bank run. What happens during a bank run?
Customers scramble to withdraw their money from a bank during a Bank run, scared that the Bank may be insolvent. When that happens, the Bank, even though not insolvent, may end up without cash to pay customers.
The last bank run happened in 2019 when false rumours spread over social media and messaging apps that MetroBank, a bank in the U.K, was trying to confiscate customers’ possessions and funds held in safe deposit boxes. If you aren’t sure what a bank run is or what happens during one, this article is what you need.
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What Happens During a Bank Run?
Before we delve into what takes place during a bank run, let’s first understand what a bank run is.
A bank run happens when many customers of a bank or other financial institution withdraw their deposit simultaneously over concerns about the Bank’s solvency. As more customers withdraw their money, the probability of default drops, pushing more people to withdraw their money. In extreme cases, the Bank’s reserves may not be enough to cater to the withdrawals.
Understanding Bank Runs:
As mentioned earlier, bank runs happen when a significant number of people start making withdrawals from banks because they fear the institutions will run out of money. A bank run is normally the result of panic rather than true insolvency.
A bank run activated by fear that forces a bank into actual insolvency represents a good example of a self-fulfilling prophecy. The Bank does risk default, as people keep withdrawing their deposits. So what starts as a mare panic can become a real default case.
That is because most banks don’t keep that much cash in their branches. In fact, most institutions have set a limit to how much they can keep in their vaults each day. These limits are set based on the need for security purposes. The Federal Reserve Bank also set in-house cash limits for institutions. The money they have on the books is used to loan out to others or is invested in different investment vehicles.
Since banks normally keep only a small percentage of deposits as cash on hand, they must raise their cash position to meet the withdrawal demands of their customers. One method a bank uses to boost cash on hand is to sell off its assets, sometimes at a loss.
Losses derived from the sale of assets at lower prices can result in the insolvency of a bank. A bank panic happens when several banks endure runs simultaneously.
Example:
Mike has deposited $200,000 in Bank ABC. Then, one day, he hears a rumour that the Bank has settled a huge debt and isn’t solvent anymore. So worried that the Bank might go bankrupt, Mike withdraws all $200,000 from his savings and checking accounts and moves them to another bank.
At home, he calls his sister and fills her in about the rumour he heard, informing him of how he withdrew all his money from the Bank. His sister tells her husband, her colleagues, and friends, and they all go and withdraw their deposits from Bank ABC. Mike posts on his Twitter account that Bank ABC may not be solvent, and he tells his 3,000 followers, who then tell their acquaintances. So, at the end of the day, over 200,000 people withdraw their money from Bank ABC.
Although the Bank wasn’t really facing solvency, the rumor and the fact that many individuals had withdrawn their money on the spot forced the Bank to give a lot of cash from its vault. So, now it cannot meet more withdrawal requests. Another round of rumors that the Bank is not solvent made the bank default.
Bank Run VS. Silent Bank Run
Bank runs are normally portrayed as a long line of bank customers earnestly waiting their turn to step up to the teller’s window and request that their accounts be closed. However, today, when a bank run happens, it is not met with lengthy lines.
A silent bank run is when depositors withdraw funds electronically without physically entering the Bank. Silent bank runs are like normal bank runs, except funds are withdrawn through ACH transfers, wire transfers, including other methods that don’t require the physical withdrawal of cash.
In some ways, these new technologies make the prospect of a bank run even more dangerous from the Bank’s view. Many traditional barriers that would have helped drag the pace of a bank run, like customers needing to wait in long lines to withdraw deposits, are no more. Similarly, customers, today don’t need to wait to place an order within a bank’s working hours. Instead, they can issue an order online, and it will be processed as soon as the Bank opens.
Meanwhile, these modern conveniences might also help banks by making the occurrence of a bank run less visible to outside observers. A depositor might be more inclined to withdraw their funds if they see others lining up outside a bank wishing to do so. With electronic withdrawal requests, the symptoms of a bank run may be less easily noticed.
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What takes place during a Bank Run?
During a bank run, customers struggle to withdraw their funds from a bank that was rumoured to be insolvent. The 9-5ers scramble to withdraw their little savings from the alleged insolvent bank, so it doesn’t go down with them. The same applies to the painter, technician, lawyer—everyone who has an account with the Bank. In the end, even if the Bank isn’t insolvent, it’ll end up being insolvent due to the massive cash withdrawal.
