Bank Runs
A bank run occurs when a large number of customers withdraw their deposits from a bank due to concerns about its solvency. This can lead to a liquidity crisis for the bank, as it may not have enough cash on hand to meet the demand for withdrawals. Bank runs can have destabilizing effects on the financial system and may necessitate intervention by regulatory authorities.
7 Key excerpts on "Bank Runs"
eBook - ePub- Edwin H. Neave(Author)
- 2010(Publication Date)
- Wiley(Publisher)
...In yet another series of examples, Bank Runs and bank failures occurred in several Asian countries during the late 1990s. The problems began with individual banks, but eventually spread throughout the banking system and ultimately affected the creditworthiness of the countries themselves. Similarly, the credit crisis of 2007–2008 began with U.S. banks and U.S. investment banks, and later spread to financial institutions in many other parts of the world. Despite failures in many countries, however, banking instability is not universal. For example, Scotland has never had a bank run, although its banking history extends over more than 300 years, beginning with the formation of the Bank of Scotland in the late 1600s. Bank shareholders faced unlimited liability during the earlier years of Scottish banking history, but even after changing to limited liability ownership the Scottish banking system exhibited no instabilities. Similarly, Switzerland reports no Bank Runs over its lengthy banking history. At least part of the explanation for such differences appears to lie in countries' political differences. Both Allen and Gale (2007) and Rochet (2008) argue that political interference can play an important role in creating difficulties. A bank run is a loss of confidence in an individual bank, and can be a proximate cause of bank failure, although the fundamental reasons for bank failure are operating or loan losses. 4 To reflect these differences, many authors distinguish between speculative and fundamental Bank Runs. Speculative Bank Runs are those in which depositors withdraw a disproportionate amount of funds from a solvent bank, while fundamental Bank Runs occur when depositors attempt to recover their funds from an insolvent bank...
eBook - ePub- Livio Stracca(Author)
- 2018(Publication Date)
- Routledge(Publisher)
...A perfectly solvent and healthy bank can be driven to bankruptcy. In reality, the truth is somewhere in the middle; Bank Runs are always initiated where there is at least a whiff of information that the concerned bank may be in trouble. That does not mean, of course, that all runs are fully justified by fundamentals. It is the same with viruses and bacteria: they are more likely to attack the sick than the healthy – which, of course, does not imply that one should let the sick die. One important downside of a bank run is that either the bank or, worse, the financial system as a whole is forced to do an inefficiently rapid de-leveraging, which in turn can severely impair credit creation (credit crunch). Moreover, bank liabilities (deposits) are used as inside money, so a contraction in bank balance sheets may also reduce the money supply. A striking example of the primary importance of this mechanism – and indeed of the importance of financial intermediation in a modern economy – is the Great Depression of the 1930s. Bank fragility and liquidity: a necessary trade-off? Banks’ vulnerability to runs is often seen as a shortcoming which needs to be prevented and corrected via public regulation. But is it necessarily bad from the standpoint of liquidity creation? The first thing to notice is that Bank Runs as a pure expectations-driven phenomenon independent of fundamentals have been relatively rare in history. In most cases, there has been some kind of real risk of insolvency for the bank being victim of a run. It is true that a run can precipitate the insolvency of a financial intermediary which could otherwise have been avoided; but the run is rarely the only or even main cause of the bankruptcy of the bank: it is rather typically an amplification mechanism. However, it can still be undesirable even only as amplification channel. The mirror image of banks’ fragility is their ability to create liquidity and there is a trade-off between these two dimensions...
eBook - ePubBanking Crises
Perspectives from the New Palgrave Dictionary of Economics
- Garett Jones, Garett Jones(Authors)
- 2016(Publication Date)
- Palgrave Macmillan(Publisher)
...These attributes magnify incentives to run banks. An early theoretical contribution, by Douglas Diamond and Philip Dybvig (1983), posited a banking system susceptible to the constant threat of runs, with multiple equilibria, where runs can occur irrespective of problems in bank portfolios or any fundamental demand for liquidity by depositors. They modelled deposit insurance as a means of avoiding the bad (bank run) equilibrium. Over time, other models of banks and depositor behaviour developed different implications, emphasizing banks’ abilities to manage risk effectively, and the beneficial incentives of demand deposits in motivating the monitoring of banks in the presence of illiquid bank loans (Calomiris and Kahn, 1991). The literatures on banking crises also rediscovered an older line of thought emphasized by John Maynard Keynes (1931) and Irving Fisher (1933): market discipline implies links between increases in bank risk, depositor withdrawals and macroeconomic decline. As banks respond to losses and increased risk by curtailing the supply of credit, they can aggravate the cyclical downturn, magnifying declines in investment, production, and asset prices, whether or not bank failures occur (Bernanke, 1983; Bernanke and Gertler, 1990; Calomiris and Mason, 2003b; Allen and Gale, 2004; Von Peter, 2004; Calomiris and Wilson, 2004). New research explores general equilibrium linkages among bank credit supply, asset prices and economic activity, and adverse macroeconomic consequences of ‘credit crunches’ that result from banks’ attempts to limit their risk of failure. This new generation of models provides a rational-expectations, ‘shock-and-propagation’ approach to understanding the contribution of financial crises to business cycles, offering an alternative to the endogenous-cycles, myopic-expectations view pioneered by Hyman Minsky (1975) and Charles Kindleberger (1978). CHARLES W...
eBook - ePub- Allen N. Berger, Christa Bouwman(Authors)
- 2015(Publication Date)
- Academic Press(Publisher)
...It then picks one that best suits the empirical analyses shown in this book, which focuses on the United States over the period 1984:Q1–2014:Q4. The chosen approach allows for the examination of crises that do not have significant policy interventions, and are generated by banking and market shocks that do not necessarily involve liquidity problems. The key takeaway is that there is no single formula or set of rules for defining and dating financial crises that is best for every situation – some judgment is needed. 1 When depositors fear that their bank is (or may become) insolvent, they may try to withdraw their funds. A bank run occurs when a large number of depositors withdraw funds. In such a situation, the bank may be forced to liquidate assets at “fire sale” prices or forego profitable investment opportunities and the bank may fail, even if the fear was unfounded. To prevent this, bank regulators may declare an emergency bank holiday, that is, closure of the bank until it was determined to be solvent. In the United States, the first bank holiday was declared by President Franklin D. Roosevelt shortly after taking office in an attempt to curb bank failures during the Great Depression. 2 The bank credit crunch of 1990:Q1–1992:Q4 is discussed in detail in Section 7.5. The savings and loan (S&L) crisis of the 1980s is discussed here. This crisis was triggered in part by historically high short-term interest rates caused by tight monetary policy from October 1979 to August 1982 that was intended to curb inflation. This caused interest rate risk losses for S&Ls who by law had to hold fixed-rate mortgages. When interest rates went up, the existing stock of these mortgages lost value and wiped out the industry’s net worth. The S&Ls also started to have operating losses because they were paying high short-term interest rates on deposits, while receiving low interest rates on long-term fixed-rate mortgages...
eBook - ePubRetail and Digital Banking
Principles and Practice
- John Henderson(Author)
- 2018(Publication Date)
- Kogan Page(Publisher)
...Should a bank overstate the value of their mortgage book, for example, and there was a sharp reduction in the property values, then this could lead to a perilous situation where the advances they have provided exceed the value of the property that is owned. This is a classic situation of negative capital or insolvency. Insolvency Occurs when a person or company has an inability to meet their financial obligations when they are due. Some crises may be isolated to an individual bank which may result in a run on the bank (as highlighted in the Overend Gurney Case Study in Chapter 1). As you will remember, this is when a single institution gets into difficulties and depositors and investors desperately attempt to withdraw their funds, leaving the bank in a position where it has insufficient cash or liquidity to fund its immediate loan repayments. Unless the cause of the bank failure can be attributed and isolated to a unique and specific set of circumstances, such as the internal fraud that led to losses of £827m, ending Barings Bank in February 1995, or the internal corruption that led to the demise of Bank of Credit and Commerce International in July 1991, then invariably broader environmental conditions may well lead to further runs on multiple banks, wider panic and systemic crises. Systemic Refers to the knock-on effects of an event that impact upon the interconnected parts of the financial system and beyond into other aspects of society. Should a bank suffer the indignity of a run happening to them, this will inevitably lead to an imbalance between being able to hand all on-demand depositors’ balances back to them and having the ability to meet short-term obligations to settle outstanding loan repayments that it is due to make...
eBook - ePubFinancial Stability and Central Banks
A Global Perspective
- Richard Brearley, Juliette Healey, Peter J N Sinclair, Charles Goodhart, David T. Llewellyn, Chang Shu, Richard Brearley, Juliette Healey, Peter J N Sinclair, Charles Goodhart, David T. Llewellyn, Chang Shu(Authors)
- 2001(Publication Date)
- Routledge(Publisher)
...Kaufman (1994), in an extensive review of the empirical literature on bank contagion in the United States, concluded that Bank Runs appear to be largely bank specific and rational, so that contagion ‘has occurred only for banks in the same market or product area as the initially affected bank’. Kaufman added that there was ‘no evidence to support the widely held belief that, even in the absence of deposit insurance, bank contagion is a holocaust that can bring down solvent banks, the financial system, and even the entire macroeconomy in domino fashion’. 5.2.2 The consequences of banking crises Banks are not the only providers of capital, and therefore are not alone in suffering periodic losses. In developed economies, a far larger part of any reduction in corporate values is borne by holders of the firms’ equity and bonds. For example, the losses borne by US equity holders on 17 October 1987 far outweighed the total losses incurred by the S&Ls in the 1980s. However, as far as I am aware, no-one has seriously suggested that there should be a government bail-out of individuals who suffer losses through their investments in stocks or mutual funds. Yet large amounts of government aid are provided to rescue banks in financial distress and banks are subject to considerable regulatory oversight to limit the likelihood that such government assistance will be called upon. Thus, falls in asset values are regarded as having wider and more serious consequences if they occur in the banking system rather than elsewhere in the economy...
eBook - ePubThe Bank Credit Analysis Handbook
A Guide for Analysts, Bankers and Investors
- Jonathan Golin, Philippe Delhaise(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
...In contrast, nonfinancial firms, with a few exceptions, are lightly regulated in most jurisdictions, and governments generally take a hands-off policy toward their activities. In most contemporary market-driven economies, if an ordinary company fails, it is of no great concern. This is not so in the case of banks. Because they depend on depositor confidence for their survival, and since governments neither want to confront irate depositors, nor more critically, contend with a significant number of banks unable to function as payment and credit conduits, deposit-taking institutions are rarely left to fend for themselves and go bust without a passing thought. Even where deposit insurance exists and depositors remain pacified, the failure of a single critical financial institution may be plausibly viewed by policymakers as likely to have a detrimental impact on the health of the regional or national financial system. Moreover, the costs of repairing a banking crisis typically far outweigh the costs of taking prudent measures to prevent one. Governments therefore actively monitor, regulate, and—in light of the importance of banks to their respective economies—ultimately function as lenders of last resort through the national central bank, or an equivalent agency. Owing to the privileged position that banks commonly enjoy, their credit analysis must give due consideration to an institution’s role within the relevant financial system. Its position will affect the analyst’s assessment concerning the probability, and degree, of support that may be offered by the state—whether explicitly or more commonly implicitly—in the case the bank experiences financial distress. Making such assessments not only calls for consideration of applicable laws and regulations, but also relevant institutional structures and policies, both historic and prospective...
