The Effects of a Bank Run on Banking Institutions

Understand the meaning of a bank run and how it affects banks

The Effects of a Bank Run on Banking Institutions

A bank run happens when many clients withdraw their money from a bank at once, typically out of concern that the bank is or will be insolvent. Customers typically ask for cash, which they might invest in government bonds or other institutions they deem to be more secure.

When some customers lost their life savings during the Great Depression, bank runs became well-known. Shortly after, the government established the Federal Deposit Insurance Corporation (FDIC), an independent organization that safeguards consumer bank deposits in the event of similar financial catastrophes that result in bank failures.

Despite the fact that this significantly reduces the risk that consumers take with their deposits, being aware of bank runs can help you avoid making irrational withdrawals that could harm banks and the overall economy.

Asset losses and sell-offs can result from bank runs

Given that U. S. Not every deposit made by a customer is immediately available in cash at the bank for withdrawal; this practice is known as fractional reserve banking. Banks only keep a small percentage of customer deposits in cash, which is kept in safes and automated teller machines (ATMs). A portion is used for loans or other types of investments, while the remainder is kept in reserves.

The majority of customers typically do not have an immediate need for their money. The demand for deposits can overwhelm a bank when many customers attempt to withdraw money at once. A bank might even be required to sell off long-term assets in order to pay its obligations.

Since the height of a financial crisis is typically a bad time for banks to redeem assets for cash, if a bank is forced to generate cash by selling investments, it may have to suffer sizable losses.

During bank runs, banks may fail

Bank runs are caused by concerns about bank insolvency, which are ultimately motivated by a fear of losing money. Customers assume (often correctly) that if a bank fails, they will lose every penny in the account. It makes sense that you would be worried; your hard-earned savings appear to be in jeopardy, so you make a hasty retreat.

Regrettably, rumors that a bank won’t release customers’ funds can come true themselves. Even if a bank is somewhat unstable, it is still not in danger of failing. But if everyone withdraws money simultaneously because they think the bank is or will be insolvent, the bank subsequently becomes significantly weaker.

The situation gets worse when a bank is unable to meet customer withdrawal requests-or even if there is just a rumor that the bank won’t be able to-and when customers become increasingly impatient. Customers may try to withdraw as much cash as they can out of fear of being the “last one to the exit” and as a result, banks may be unable to give customers their money. In the worst case, a bank might become insolvent, which would result in total failure. The likelihood of insolvency rises during and after a panic if a bank wasn’t already going to fail.

An economic downturn can result from a bank run at a single financial institution or on a national scale. Account holders or investors may even try to transfer money to foreign banks if they believe that the banking or financial system of a particular nation is about to collapse.

Lehman Brothers collapsed in September 2008, and eventually the entire investment banking industry, as a result of the global financial crisis, which was also notable for its bank runs.

Banks and customers are protected from runs by the FDIC

Consumers now feel more secure about their deposits thanks to the FDIC’s implementation of nationwide bank deposit insurance, which also reduces the frequency of bank runs and subsequent failures.

Some experts contend that despite the existence of the FDIC, there is still a risk of bank failures because banks might maintain the bare minimum of cash reserves required by the FDIC and might have more liabilities than they disclose on their balance sheets, both of which could pave the way for eventual insolvency.

However, the majority of U.S. S. won’t lose money even if runs do happen and their bank fails. In actuality, they might not experience any real inconvenience. Customers at participating banks may receive complete or partial protection from financial losses in the event that a bank fails thanks to FDIC insurance. Through the National Credit Union Share Insurance Fund (NCUSIF),  Federally insured credit unions are similarly protected. In either scenario, protection is typically capped at $250,000 per depositor, per institution, and per ownership category.

When an open bank takes over the deposits of a closed bank, covered customers of the closed bank are still able to write checks, deposit money, and send electronic transfers as if nothing had happened. Eventually, they might notice that the name and logo on their statements have changed, but their account balance would still be the same as it would have been had the bank remained open.

You may occasionally be able to insure more than $250,000 in deposits at one bank thanks to the FDIC insurance limit’s “per ownership” rule. A trust account with three different beneficiaries, for instance, might allow you to insure $750,000.

The Final Verdict

An economic downturn as well as bank losses and failures are possible outcomes of bank runs, which is a terrifying thought. The availability of deposit insurance, however, makes them less likely today, and they typically aren’t justified unless depositors aren’t completely covered by the FDIC or NCUSIF or a complete financial system collapse is on the horizon and you’re worried that your money will lose all of its value.

By keeping your money in up-to-the-limit FDIC- or NCUSIF-insured accounts and refraining from herd behavior, you can lessen the panic that leads to bank runs and even contribute to the support of the economy.

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