What Is A Bank Run?
In times of crisis, people seek certainty. They want to know that their hard-earned money is safe and secure. But what happens when everyone has the same idea at once? Can a bank run out of cash if everyone simultaneously withdraws their money? The answer is a resounding "yes," and it's called a bank run.
During periods of financial instability, such as the Great Depression of the 1930s and the global financial crisis of 2008, a bank run begins. Commercial bank customers start to believe that the bank may close and lose their money, which becomes a self-fulfilling prophecy. They form a mass withdrawal of their savings, leading to a run on the bank. This vicious cycle continues as banks lose financial liquidity and savers pull out their deposits. News of this reduces confidence in the bank's stability, leading to even more savers pulling out their deposits. Eventually, the bank becomes insolvent, and its cash reserves run dry. They end up imposing restrictions on withdrawals, and at that point, the jig is essentially up.
You might be wondering how this can happen. The two main priorities of a commercial bank are to handle deposits and withdrawals from customers, so shouldn't there be safeguards for this kind of thing? The problem with bank runs is that they're pretty much tailored to take advantage of vulnerabilities inherent in the system. There are regulations on how much physical cash your local bank branch can keep on its premises for their expected daily usage of said cash and security reasons. In other words, if a bank's vault carries way more cash than it needs on an average day, and that bank is robbed, that's an extremely expensive robbery right there.
The Federal Reserve also limits the amount of in-house cash a bank can carry, and even this cash isn't all entirely devoted to customer savings withdrawals. This is called fractional reserve banking - as each bank only keeps a fraction of its overall cash reserves for daily use. Banks also need this cash to provide money for small in-house loans and investment projects. When the bank's customer base pulls out money like crazy, they need to siphon extra cash from other areas to keep up with withdrawal demand. This is known as increasing their cash position.
To increase their cash position quickly so they can keep up with demand, banks in the process of a bank run often sell off their assets at significantly lower than the asking price. The selling off of assets goes public, which feeds into public panic and more withdrawals. Banks will be hemorrhaging money throughout this process to stay above water. These financial catastrophes are a mix of economics and mob psychology, as increasing general instability manifests directly in the instability of the bank. As bank runs typically happen in times of crisis, selling off long-term investment assets will fetch an even lower price than usual, plunging the financial institutions further into the hole.
While one might think it would be easy to nip a bank run in the bud by quelling the fears of the consumer base and assuring them that a panicked withdrawal will only worsen the situation, talking sense into the public is often easier said than done. The lead-up to a bank run can almost feel like a stalemate - just like nobody in a standoff situation wants to be the first to put down their gun, customers fear being the "last one to exit" and losing their hard-earned savings if the bank does eventually fail. The cruel irony is that fear that a bank will fail is often one of the most significant contributors to its failure.
During economic instability, we have seen bank run scenarios like recently with Silicon Valley Bank and Credit Suisse. And somehow, regardless of what is happening in traditional markets, market cap leaders in cryptocurrencies like Bitcoin have seen an increase in market capitalization. Are we seeing institutional and retail investors flocking back into BTC? I don't know, but seeing how this develops as the year goes on will be interesting.
Thank you for reading and hope you have a good rest of the day!
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