Bank Run

The term Bank Run refers to a simultaneously withdraw of money from a bank by its depositors, due to a fear that the bank will become insolvent. The bank run usually begins with depositors beginning to worry that the bank has financial problems. The second stage of the bank run is when the panic ensues and majority of its depositors literally run to the bank to withdraw their savings, before the bank goes underwater. The bank run becomes worse as more and more depositors withdraw their money and exponentially increase the chances of bank failure.

Why are Bank Runs Possible?

Bank runs are possible because of the fractional reserve banking system employed by all banks worldwide. In simple words banks are allowed to lend much more many that they actually have on deposit with them. For example if John deposits $1,000 with his bank, his bank might be able to lend out $10,000 (this ratio depends on each country's banking laws), thus creating money out of thin air. Further more the bank keeps a very small part of the depositors' money in cash, and the rest is invested. This of course creates problem if even relatively small number of depositors demand to withdraw their cash at the same time.

The most recent, highly publicized bank run happened in September 2007 to the Northern Rock bank based in UK. In just a few days the bank's depositors withdrew over 2 billion GBP. This forced the Her Majesty Treasury to issue a statement that it will guarantee all savings deposited in Northern Rock, which ultimately ended the bank run.

Most of the time governments bail out banks with taxpayers' money when bank run happens, instead of leaving them to fail as would any other private business. This is unfair and irresponsible practice leading banks to believe that no matter how stupid and bad business decisions they make the government will always save them.