Bank Runs

When Customers Flock to the Exits

Black and White Bank Line
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A bank run is an overwhelming demand from customers to pull their money out of the bank.

Customers might fear that the bank is about to fail, so they withdraw as much as they can (trying to get their assets out before it’s too late). They line up at ATMs and withdraw as much as possible, they wait for banking hours so they can withdraw from tellers, and they move money out of the bank electronically.

Why they Happen

Bank runs are based on the fear of losing money. Customers think (sometimes accurately) that if a bank goes belly-up, they’ll lose all of their money in the bank. This fear is understandable – your hard-earned savings seem to be at risk – and everybody makes a desperate rush for the exits.

Unfortunately, bank runs can create self-fulfilling prophesies. A bank might be on somewhat shaky ground, but far from failure. However, when everybody pulls funds out – all at once – the bank suddenly becomes much weaker. If it wasn’t going to fail before, the likelihood of insolvency increases during and after the panic. The bank might be forced to come up with cash at an inconvenient time, which often means taking losses on investments (the middle of a financial crisis is generally a bad time for the bank to sell assets and drum up cash).

Panic can easily intensify during bank runs. In most cases, banks don’t keep your money in the bank.

All of the customer deposits are not sitting in the vault waiting for you to come and cash out. Instead, banks invest that money. What’s more, a bank might only have 10% of total customer assets available in liquid form (again, these funds are not sitting at the bank branch – they’re just easily available to the bank) due to fractional reserve banking.

Most customers don't need access to all of their cash all of the time – that's why it's in the bank. However, during a bank run everybody wants out, and they want all of their money in hand.

Bank runs can also happen on a national level (as opposed to a run on a single bank). If people think that the banking system in a given country is about to collapse, they'll pull money out as quickly as possible.

Do Bank Runs Make Sense?

Again, bank runs are a result of a very scary prospect: losing all of your money. But in general, bank runs are unnecessary. Most depositors in the United States will not lose money if their bank fails. In fact, they might not be inconvenienced in any meaningful way.

The FDIC ensures that covered customers will get their money, within certain limits. Credit union customers are similarly covered (with a US government guarantee) by NCUSIF insurance. If you’ve got uninsured deposits or you will need significant funds in the immediate future, then the fear makes more sense. However, most people are not in that situation.

In many bank failures, covered customers can continue to write checks, deposit money, and make electronic transfers as if nothing happened. At some point, they may notice that the name and logo on their statements change, but their account balance is the same as it would have otherwise been regardless of the bank’s failure.

Those who are not fully covered by the FDIC are in a worse situation. Given the number of choices you have for spreading your money around, why take that risk?. Likewise, a total collapse of the financial system might warrant a bank run, but what would your money be worth anyway if your country collapsed?

Bank runs gained notoriety around the time of the Great Depression, when consumers really did lose all of their money. Shortly after that, the FDIC was formed, and the risk consumers take is dramatically less than it used to be.