Definition: A bank run takes place when consumers simultaneously withdraw their deposits in the fear that the bank is not solvent influencing more consumers to withdraw their funds and most likely causing the bank to default.
What Does Bank Run Mean?
What is the definition of bank run? The current banking regulation in the United States holds that the banks and the economy should align in order to protect consumers from the impact of bank runs. Some economists believe that the runs on banks that took place between 1930 and 1933, eventually leading to the Great Depression are responsible for a lot of bank defaults. In fact, bank runs destabilize the economy and the banking system. Therefore, the Federal Reserve requires banks to keep 10% of their deposits in a Federal Reserve account to ensure enough cash in the case of a run on the bank.
Let’s look at an example.
Example
Jonathan has deposited $100,000 in Bank ABC. Over the last two days, he hears rumors that the Bank is not solvent anymore, and that it may go bankrupt. So, worried about his money, Jonathan withdraws all $100,000 from his savings and checking accounts and transfers them to another bank.
On the way home, he calls his brother, and he tells him about his worries and that he has withdrawn all his money from the bank. His brother tells his wife, his parents, his in-laws, and his best friend, and they all go and withdraw their funds from the bank. Jonathan posts on Facebook that the Bank ABC may not be solvent, and he informs his 1,500 friends, who then inform their circle of people. So, at the end of the day, more than 150,000 people withdraw their funds from Bank ABC.
Although the Bank was not really facing such a major problem, the rumors and the fact that so many people have withdrawn their funds on the spot has forced the bank to give a lot of cash from its vault. So, now it cannot meet more withdraw requests. Another round of rumors that the bank is not solvent caused the bank to eventually default.
Summary Definition
Define Run on the Bank: Bank run means a large number of depositors withdrawal their funds from the bank at the same time influencing other depositors to do the same causing the bank to have insufficient funds.
