Understanding Bank Runs
A bank run refers to a situation where customers rapidly withdraw money from banks due to fear or panic that the institutions may run out of funds. At any given time, a bank only holds a limited cash reserve, while the remainder is invested or loaned to businesses.
During a bank run, the bank may not have sufficient cash to meet the withdrawal demand. This lack of physical cash to satisfy customer requests can deplete funds as more customers withdraw money from their accounts, increasing the bank’s risk of collapsing or going bankrupt.
In the financial industry, customers play a crucial role in determining the stability of an institution. Banks typically operate smoothly when customers have confidence that their money is secure and there is no cause for alarm.
Causes of Bank Runs
Bank runs can be triggered by the rapid spread of rumors suggesting that a bank is facing a shortage of funds in its reserve. Negative sentiments arising from these rumors can induce fear and anxiety in customers, prompting them to withdraw their money without verifying the accuracy of the information.
A bank run can also result from a specific branch’s localized cash shortage. If a branch runs out of cash, customers may be unable to withdraw funds from that location. If similar cash shortages occur in multiple branches, news of insolvency can spread, leading to further withdrawals and putting the bank at risk of a systemic banking crisis.
Historical Examples of Bank Runs
Bank runs have occurred throughout history, with the most notable example being during the Great Depression. Following the stock market crash, people lined up outside banks to withdraw funds, triggering a widespread bank run.
In more recent times:
Silicon Valley Bank (2023)
The collapse of Silicon Valley Bank in March 2023 was a result of a bank run caused by venture capitalists. The bank reported that it needed $2.25 billion to shore up its balance sheet, and by the end of the following business day, customers had withdrawn about $42 billion. As a result, regulators closed the bank and took control of its assets. Silicon Valley Bank had last reported $209 billion in assets as of the fourth quarter of 2022, making it the second-largest bank failure of all time.
Washington Mutual (WaMu) (2008):
Washington Mutual (WaMu), which had about $310 billion in assets at its failure, was the largest bank failure in the U.S. Several factors, including a poor housing market and rapid expansion, caused its collapse. The bank also suffered a run when customers withdrew $16.7 billion within two weeks. JPMorgan Chase eventually bought Washington Mutual for $1.9 billion.
Wachovia Bank (2008)
Wachovia Bank was also shuttered after depositors withdrew more than $15 billion over two weeks after Wachovia reported negative earnings results. Wells Fargo eventually acquired Wachovia for $15 billion. Much of the withdrawals at Wachovia were concentrated among commercial accounts with balances above the limit insured by the Federal Deposit Insurance Corporation (FDIC), drawing those balances down to just below the FDIC limit.
Preventing Bank Runs
After the 2008 economic collapse, authorities implemented measures to prevent and address bank runs at their root causes. Some of these measures include:
- Increasing banks’ minimum cash reserve requirement enables them to meet withdrawal demands during a bank run.
- Ensuring customers that their funds are secure and reserved through implementing a more transparent banking system.
- Allowing banks to close their operations when withdrawal demands become excessive temporarily, thus increasing their cash reserves.
- Encouraging banks to maintain an ideal liquidity ratio to enhance their overall stability.
These measures aim to build confidence in the banking system, reassure customers, and mitigate the risk of bank runs.