What is a Bank Run?
A bank transfer occurs when a large number of customers of a bank or other financial institution simultaneously withdraw their deposits for reasons of solvency of the bank.
As more and more people withdraw their funds, the probability of default increases, prompting more people to withdraw their deposits. In extreme cases, the bank’s reserves may not be sufficient to cover withdrawals.
Understanding bank executions
Bank breaks occur when large numbers of people start withdrawing from banks for fear that institutions will run out of money. A bank transfer is usually the result of panic rather than true insolvency. A fear-driven bank race that drives a bank to real insolvency is a classic example of a self-fulfilling prophecy. The bank risks defaulting as individuals continue to withdraw funds. So what starts out as a panic can eventually turn into a real default situation.
This is because most banks do not keep as much cash in their branches. In fact, most institutions have a fixed limit on what they can store in their vaults each day. These limits are set according to needs and for security reasons. The Federal Reserve Bank also sets internal cash limits for institutions. The money they have on the books is used to lend to others or is invested in different investment vehicles.
Since banks generally only keep a small percentage of cash deposits, they need to increase their cash flow to meet their customers’ withdrawal requests. A method used by a bank to increase liquidity is to sell its assets, sometimes at prices significantly lower than what it should not sell quickly.
Losses on the sale of assets at lower prices can lead to the bankruptcy of a bank. A bank panic occurs when several banks are executed at the same time.
- A bank transfer occurs when large groups of customers withdraw their money from banks simultaneously, fearing that the institution may become insolvent.
- With more people withdrawing money, banks will use their cash reserves and eventually default.
- The Federal Deposit Insurance Corporation was created in 1933 in response to a bank transfer.
Prevent bank transfers
In response to the turmoil of the 1930s, governments took several measures to reduce the risk of future bank exits. Perhaps the most important was to establish reserve requirements, which require banks to keep a certain percentage of total cash deposits.
In addition, the United States Congress created the Federal Deposit Insurance Corporation (FDIC) in 1933. Created in response to the many bank failures that had occurred in previous years, this agency insures bank deposits. Its mission is to maintain public stability and confidence in the American financial system.
But in some cases, banks need to take a more proactive approach if they are faced with the threat of bank flight. Here’s how they can do it.
1. Slow down. Banks may choose to close for a period of time if they are faced with the threat of a bank leak. This prevents people from queuing and withdrawing their money. Franklin D. Roosevelt did so in 1933 after taking office. He declared a holiday, calling for inspections to ensure the solvency of the banks so that they can continue to operate.
2. Borrow. Banks can borrow from other institutions if they do not have enough cash reserves. Large loans can prevent them from going bankrupt.
3. Insure deposits. When people know that their deposits are insured by the government, their fear usually subsides. This has been the case since the creation of the FDIC by the United States.
Central banks generally act as a last resort to grant loans to individual banks during crises such as a banking crisis.
Examples of bank transfers
The stock market crash of 1929 precipitated a series of bank ruptures (and bank panics) across the country, ultimately leading to the Great Depression. The succession of bank breaks that occurred in late 1929 and early 1930 was somewhat domino, while the news of a bankruptcy frightened customers of nearby banks, prompting them to withdraw their money. For example, a single bank failure in Nashville has led to a multitude of banks across the Southeast.
Other bank sinkings during the Depression took place due to rumors launched by individual customers. In December 1930, a New Yorker who had been advised by the Bank of the United States to sell a particular security left the branch and quickly began to tell people that the bank did not want or could not sell its shares. Interpreting this as a sign of insolvency, bank customers lined up in their thousands and, within hours, withdrew more than $ 2 million from the bank.