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Bank run

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	Bank run
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	Topics Bank run Topic Home A bank run (also known as a run on the bank) is a type of financial crisisFinancial crisis Overview A financial crisis is a situation when money demand quickly rises relative to money supply.... . It is a panicPanic Summary Panic is the primal urge to run and hide in the face of imminent disaster.... which occurs when a large number of customers of a bankFacts About Bank A bank is a business that provides banking services for profit.... withdraw their deposits because they fear it is, or might become, insolventInsolvency Summary Insolvency is a financial condition experienced by a person or business entity when their assets no longer exceed their liab... . This action can destabilize the bank to the point where it becomes insolvent. Banks retain only a fraction of their deposits as cash (see fractional-reserve bankingFractional-reserve banking In economics, particularly in financial economics, fractional-reserve banking is the near-universal practice of banks having... ): the remainder is invested in securities and loanLoan A loan is a type of debt. All material things can be lent but this article focuses exclusively on monetary loans.... s. No bank has enough reservesReserves The term reserves could be used to refer to:... on hand to cope with more than the fraction of deposits being taken out at once. As a result, the bank faces bankruptcyBankruptcy Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay their creditors.... , and will 'call in' the loans it has offered. This can cause the bank's debtors to face bankruptcy themselves, if the loan is invested in a plant or other items that cannot easily be sold. A banking panic or bank panic occurs if many banks suffer runs at the same time. The resulting chain of bankruptcies can cause a long economic recession. As a bank run progresses, it generates its own momentum, in a kind of self-fulfilling prophecySelf-fulfilling prophecy A self-fulfilling prophecy is a prediction that, in being made, actually causes itself to become true.... . As more people withdraw their deposits, the likelihood of default increases, so other individuals have more incentive to withdraw their own deposits. A bank run is a kind of positive feedbackPositive feedback Positive feedback is a feedback system in which the system responds to the perturbation in the same direction as the perturb... loop which has much in common with the reflexive processes described by George SorosGeorge Soros Overview George Soros is a financial speculator, stock investor, liberal political activist, and philanthropist.... , amongst others. Another example of a reflexive process is economic bubbleEconomic bubble * The South Sea Company* Mississippi Company... . Theory Diamond and Dybvig developed an influential model to explain why bank runs occur and why banks issue deposits that are more liquidMarket liquidity Market liquidity is a business or economics term that refers to the ability to quickly buy or sell a particular item wi... than their assets. The model starts with the observation that many productive assets, like store inventories and real estate, are illiquid, in that they are hard to sell immediately without taking a substantial loss. Also, individual investors in illiquid assets sometimes have a sudden, unpredictable need for liquidity, for example, to fund an entrepreneurial project that must be started quickly; and they are hampered because they cannot easily predict when these opportunities arise. By offering liquid deposit accounts from which money can be withdrawn at any time, and by using the proceeds to finance investment in illiquid assets, banks act as insurance arrangements that allow depositors to share the risk of losses due to early liquidation. If only a few depositors withdraw at any given time, this arrangement works well. If not, the bank itself (as opposed to individual investors) may run short of liquidity, and depositors will rush to withdraw their money, forcing the bank to liquidate its assets at a loss, and eventually to fail. If such a bank calls in its loans early, this may force businesses to disrupt their production, or individuals to sell their homes, causing further losses to the larger economy. A bank run can occur even when started by a false story. Even depositors who know the story is false will have an incentive to withdraw, if they think other depositors will believe the story. The story becomes a self-fulfilling prophecySelf-fulfilling prophecy A self-fulfilling prophecy is a prediction that, in being made, actually causes itself to become true.... . Indeed, Robert K. MertonRobert K. Merton Robert King Merton was a distinguished American sociologist perhaps best known for having coined the phrase "self-fulfilling... , who coined the term self-fulfilling prophecy, mentioned bank runs as a prime example of the concept in his book Social Theory and Social StructureSocial Theory and Social Structure Social Theory and Social Structure was a landmark publication in sociology by Robert K.... . Prevention Several techniques can be used to help prevent bank runs. Individual banks Some prevention techniques apply to individual banks, independently of the rest of the economy. A bank can take deposits from depositors who do not observe common information that might spark a run. For example, in the days before deposit insurance, it made sense for a bank to have a large lobby and fast service, to prevent a line of depositors from extending out into the street, causing passers-by to infer that a bank run is occuring. A bank can temporarily suspend withdrawals to stop a run. In many cases the threat of suspension prevents the run, which means the threat need not be carried out. Bank regulationBank regulation Bank regulations are a form of government regulation which subject banks to certain requirements, restrictions and guideline... or other constraints can impose a reserve ratio requirement, which limits the proportion of deposits which a bank can lend out, making it less likely for a bank run to start. This practice sets a limit on the fraction in fractional-reserve bankingFractional-reserve banking In economics, particularly in financial economics, fractional-reserve banking is the near-universal practice of banks having... ; in the extreme and hypothetical case, full-reserve bankingFull-reserve banking Full-reserve banking is a theoretically conceivable banking practice in which all deposits, banknotes, and notes in a financ... requires a reserve ratio of 100%. Collective prevention Some prevention techniques apply across the whole economy, though they may still allow individual institutions to fail. These techniques create moral hazardMoral hazard In insurance theory, moral hazard is the name given to the increased risk of problematic behavior, and thus a negative outco... , since they reduce incentives for banks to avoid making risky loans; the goal is for the benefits of collective prevention to outweigh the costs of excessive risk-taking. Central banks act as a lender of last resortLender of last resort A lender of last resort is an institution willing to extend credit when no one else will. ... . To prevent a bank run, the central bank guarantees that it will make short-term loans to banks, to ensure that, if they remain economically viable, they will always have enough liquidity to honor their deposits. Deposit insuranceDeposit insurance Deposit insurance is a measure taken by banks in many countries to protect their clients' savings, either fully or in part, ... systems (the Federal Deposit Insurance CorporationFederal Deposit Insurance Corporation The Federal Deposit Insurance Corporation is a created by the Glass-Steagall Act of 1933.... in the United StatesUnited States The United States of America, also known as the United States, the U.S., the U.S.A., and America, is... ) insure each depositor up to a certain amount, so that depositors' savings are protected even if the bank fails. This removes the incentive to withdraw one's deposits simply because others are withdrawing theirs. Recent incidents In 2001, during the Argentine economic crisis (1999-2002)Argentine economic crisis (1999-2002) The Argentine economic crisis was part of the situation that affected Argentina's economy during the late 1990s and early 20... , a bank run and corralitoCorralito Summary *Corralito* was the informal name for the economic measures taken in Argentina at the end of 2001 by Minister of Economy D... was experienced in ArgentinaArgentina Argentina is a country in southern South America.... . There are various theories into the cause. This contributed towards the bank runs in neighbouring UruguayUruguay Uruguay, officially the Eastern Republic of Uruguay or the Republic East of the Uruguay , is a country located ... during the 2002 Uruguay banking crisis2002 Uruguay banking crisis Summary The Uruguay Banking Crisis was a major banking crisis that hit Uruguay in July 2002 in which a massive run on banks by depos... . In early August 2007, the American firm, Countrywide FinancialCountrywide Financial Overview Countrywide Financial Corporation is a diversified financial service holding company engaged primarily in residential mortgage ban... suffered a bank run as a consequence of the subprime mortgage crisisSubprime mortgage crisis The subprime mortgage crisis is an ongoing economic problem manifesting itself through liquidity issues in the global bankin... . On 13 September 2007, the BritishUnited Kingdom The United Kingdom of Great Britain and Northern Ireland is a country and sovereign state that lies off the northwest coast... bank Northern RockNorthern Rock Northern Rock is a British bank based at Regent Centre near Newcastle Upon Tyne in northern England.... arranged an emergency loan facility from the Bank of EnglandBank of England Overview The Bank of England is the central bank of the United Kingdom, sometimes known as "The Old Lady of Threadneedle Street... , which it claimed was the result of short-term liquidity problems. The bank's defenders claimed its cash shortage was the result of over-exposure to the failing US sub-prime mortgage market, while its critics argued that it was the result of NR's own careless lending practices. A run began the following day, Friday, with reports of its internet banking site being overloaded, and long queues outside branches that day, Saturday morning and the following Monday. News reports on 17 September stated that an estimated £2 billion GBP of retail deposits had been withdrawn by customers since the bank had applied for emergency funds. On Tuesday, 11 March 2008, a bank run began on the securities and banking firm Bear StearnsBear Stearns The Bear Stearns Companies, Inc. is the parent company of Bear, Stearns & Co.... . While Bear Stearns was not an ordinary deposit-taking bank, it had financed huge long-term investments by selling short-maturity bonds, making it vulnerable to panic on the part of its bondholders. Credit officers of rival firms began to say that Bear Stearns would not be able to make good on its obligations. Within two days, Bear Stearns's capital base of $17 billion had dwindled to $2 billion in cash, and Bear Stearns told government officials that it saw little option other than to file for bankruptcy the next day. By 07:00 Friday, the Federal Reserve decided to lend Bear Stearns money, the first time since the Great DepressionGreat Depression The Great Depression was a worldwide economic downturn which started in 1929 and lasting through most of the 1930s.... that it had lent to a nonbank. Stocks sank, and that day JPMorgan Chase began an effort to buy Bear Stearns as part of a government-sponsored bailout. The deal was arranged by Sunday in an effort to calm markets before overseas markets opened. On 11 July, 2008, U.S. mortgage lender IndyMac BankIndyMac Bank IndyMac Bancorp, Inc. is the holding company for IndyMac Bank®, the largest savings and loan in Los Angeles County and the 7... was seized by federal regulators. IndyMac had been a stressed institution for months, was capital-constrained and possibly heading for regulatory intervention. However, both regulators and the bank itself blamed its troubles on a letter from Sen. Charles E. Schumer questioning its viability. Following the public release of the letter on June 26, IndyMac customers withdrew amounts averaging $100 million a day from the bank, or a total of $1.3 billion in cash. The run caused a liquidity crisis which forced IndyMac to announced it was halting new loan submissions, closing its retail and wholesale lending divisions, and laying off 3,800 employees.