A bank run (also known as a run on the bank) occurs when a large number of customers look to withdraw their deposits in unison due to concerns about a bank’s solvency (the ability of an institution to meet its long term financial obligations) leading to a capital flight.
A capital flight (or flight of capital) takes place when customers transfer funds from their account to a separate institution or demand to withdraw their assets in cash. In a fractional-reserve banking system where banks only keep a small proportion of their assets as cash, banks must liquidate loans in order to meet the demand for withdrawal. As these withdrawals increase, it tends to create a snowball effect and the probability of the bank defaulting increases as a general feeling of consternation rises. These situations can destabilise the bank such that they can run out of cash and ultimately face bankruptcy, the event at which a bank can no longer repay their outstanding debts.
As a result, banks may limit the amount of cash that can be withdrawn by a customer, suspend withdrawals altogether or acquire more cash from other banks and/or the central bank to help prevent a bank run.
Bank runs during the Great Depression
During the Great Depression banking panics set in as numerous bank runs hit a myriad of financial institutions. Beginning in the Upper-South in November 1930, corresponding networks began to fall apart as a string of banks in Tennessee and Kentucky collapsed a year after the stock market crash. These bank runs then grew to envelope almost all of the United States creating a systemic banking crisis leading to a 50% plunge in international trade and a rise in unemployment by 25%.
Bank runs today
In the past decade, we have seen bank runs across the world. For example:
Northern Rock (United Kingdom) – The global banking crisis which began in 2007 meant that Northern Rock was unable to produce income as expected from its loans and was at risk of being unable to repay the amounts it had borrowed. The news that the bank had approached the government for support led, within 24 hours, to a public lack of confidence and concern that savings were at risk. The bank failed following a bank run as people rushed to withdraw their savings. It was the first British bank in 150 years to fail due to a bank run.
Countrywide Financial (United States) – After notifying the US Securities and Exchange Commission (SEC) that the secondary mortgage markets could hurt the bank financially, people began to speculate Countrywide was a potential bankruptcy risk. On August 10th 2007, a run on the bank began as the secondary mortgage market shut down, curtailing new mortgage funding.