Bank Run

What is a Bank Run?

A Bank run takes place when a considerable number of customers of a specific financial institution or a bank start withdrawing deposits because of the fear that the bank may soon run out of enough money.

As more and more people withdraw, the chances of the bank going Default increases, compelling more people to withdraw their money. In extreme situations, the reserves of the bank might not be sufficient to cover all the withdrawals.

Why are Bank Runs Bad?

Instead of real Insolvency, a bank run occurs typically due to sheer panic. Triggered by the public’s fear, if a bank run happens and pushes the bank in the true insolvency, it is the example of self-fulfilling prophecy.

This may also lead to a bank going default in actual. Considering that a majority of banks don’t have enough cash in their branches, it can turn out to be incapable of issuing everybody’s funds. In fact, most of the banks also have a set limit of the amount that they must keep in their branches because of security issues.

Now, if everybody starts withdrawing, the bank would have to increase the cash position to meet the requirement. One popular method to do so is by selling the assets, sometimes at a lower price as well.

These losses occurring because of selling assets at the lower price can make the bank go broke. A situation of bank panic may also arise if several banks start facing the situation of a bank run at the same time.

How to Prevent Bank Runs?

Responding to this turmoil, banks and financial institutes can take a variety of steps to thwart the risk of bank runs in the future. However, in case the situation comes up, banks would have to rely on a proactive approach. Here are a few tips that they can imply for the same:

• Banks must assure the public about the safety of their deposits; this subsides the fear gradually.
• If banks are unable to take out enough cash from their branch, they can borrow the money from other institutions; thus, avoiding the situation of going bankrupt.
• If the threat of a bank run is there, institutions can opt for shutting down for a specified period. This can prevent people from gathering amass and withdrawing money.