WHAT IS A BANK RUN:
Bank run occurs when a large number of bank or any financial institution users are simultaneously making withdrawal of their fund or money because they are scared of the bank’s or institution’s solvency or the ability of to meet its long-term debts and financial obligations.
This is possible because of the fear, uncertainty and doubts this can cause and as more people withdraw their funds, the probability of the the institution’s inability to meet up with the obligation increases, prompting more people to come take away their deposits. In extreme cases, the bank’s reserves may not be sufficient to cover the withdrawals.
Understanding Bank Runs
When a large number of people are withdrawing their funds or money from the bank in fear that the bank won’t be able to meet up with its financial obligations, that situation is called Bank Run. Panic, fear, doubts and uncertainty is the reasons where bank runs occur rather than the inability of the institution carrying out its financial obligations.
Although Bank run is triggered by fear, doubts and uncertainty but majorly by fear, it is a good example of what is known as self fulfilling prophecy because as people continue to withdrawal their funds from the bank and not returning to deposit the bank is going to eventually default its financial obligation which will them increase the fear and the number of people to come withdraw their funds. So, what began as a fear triggered situation can result into an actual true default.
The reason to the above situation is because majority or all of the banks don’t keep that much cash on hand in their branches. It is known fact that most institutions have limit to how much they can store in their vaults each day and these limits are set based on need and for security reasons.
Even if some of these institutions want to keep more money in their vaults, the Federal Reserve Bank also sets in-house cash limits for institutions. The money they do have on the books is used to loan out to others or is invested in different investment vehicles or platforms.
PREVENTING BANK RUN
1. Slow it down. Sometimes bank may decide to shut it down for a period of time to prevent people from lining up to withdraw their funds from the bank. When they are not available to your reach then you’ll have to calm down a little bit. Franklin D. Roosevelt did this in 1933 after he assumed office. He declared a bank holiday, calling for inspections to ensure banks’ solvency so they could continue operating.
2. Borrow. Banks borrow money too, if you don’t know, now you know. Banks can borrow money from other institutions when they don’t have enough cash reserve. A loan of large sum can prevent defaulting.
3. Insure deposits. When people know their deposits are insured by the government or any money assurance company, their fear generally subsides. This is why FDIC was established.
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