What Is A Bank Run And How Is It Caused?

June 23, 2012 by  Filed under: Credit 

How Banks Handle Money

Most people know that banks are in the money business by accepting deposits from one population group and producing loans out to a different population group. As a saver you go to a bank and hand over your money in the confidence that they’re going to take care of it, and in return you will get interest (dependent on your physical location on the planet, interest in 2012 is incredibly low). Unless you deposit your hard-earned money with a bank for a period that cannot be broken, through something which is regarded as a CD, or Certificate of Deposit, you basically make a demand deposit.

This simply means that you pay in cash with a financial institution and may at any moment go to your financial institution and ask for your money returned back to you or transferred to an alternative bank account in another bank or investment company. Although you have minimal control over specifically what the banking institution really does with your money after you leave, you still have, in theory, complete control over whether or not your hard earned cash stays in that bank.

With regards to being aware of what a bank run is an individual needs to comprehend the following. Let’s say you deposit $1000 with the bank in a demand deposit account, allowing you to take out the cash when you so choose. The bank works with a portion of that money (about 90%) to create financial loans for some other individuals and charge them interest on those financial loans. Thousands of other folks do exactly the same thing and the banking institution in essence simply holds a fraction of the deposits promptly available, thus the term Fractional Reserve Banking.

All is okay as long as those who got the loans keep making payments, and people who deposit money do not want to pull out considerable amounts within a short period of time.

What Triggers A Bank Run?

In typical economic conditions in which there are no increased levels of bank loan defaults, this system of fractional reserves performs without too many people being worried about it. The difficulty appears when there is some form of large scale worry, panic or hysteria. The latest crisis can really be described as a panic scenario, and as we all lived through it we ought to have a good understanding of exactly what the general feeling was like.

For any run on a bank to be triggered some bad, sorry, very bad headlines ought to make it out to the public usually by way of the media. Bad information may include, however is not confined to, a significant deception scandal, unforeseen losses on the loans made, a crippling information systems problem or sudden deterioration in the financial system.

A lot of these conditions may then cause a great deal of individuals who have deposits with a financial institution to arrive at their bank in order to withdraw or transfer their money. Keep in mind the way I just said that with the Fractional Reserve Banking system, banking institutions only hold a portion of customer’s deposits readily obtainable, generally approximately 10%? All it effectively takes for bank to be compelled to shut its front doors is for more than 10% of its deposit holders to demand their money.

If you want to know a little bit more about the history of bank runs as well, why not check out this bank run article.

You can also find some of my other articles here: http://www.infobarrel.com/Users/DaddyDadChris

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