Saga of Financial Markets


Last updateSat, 29 Jul 2017 12am

Back You are here: Home Market Market Update Insight Why Bank Runs is a concern?

Why Bank Runs is a concern?

The primary key role of a bank is to take short term deposits from lenders and then makes longer term loans to borrowers.  The major risk is bank runs - when depositors ask for their money in large numbers at a time when the bank does not have the liquid resources to meet these demands.  It can cause a rational stampede to withdraw money, since depositors who wait until late in the day can lose all of their money.

The Great Depression (1929-1933) in the United States is the classic account of the bank runs crisis as the failure of the Bank of United States in December 1930 led to multiple bank runs across the country.  Bank failures in the following two years wiped out personal savings and greatly exacerbated the collapse of demand in the economy.

The standard central bank response to this problem is to provide enough liquidity to solvent banks to ensure that deposit holders are always able to withdraw their money, in which case the panic is eventually supposed to subside.

Milton Friedman and Anna Schwartz concluded that the collapse was largely the fault of the Federal Reserve, which failed to provide enough liquidity to keep the banks functioning and thus end the panic. After the crash, the establishment of the Federal Deposit Insurance Corporation was intended to ensure that deposit holders never again had to live in fear that their savings would be in jeopardy.

bank_runIn the case of Eurozone crisis, the ECB has done its role to the full extent required.  Yet, deposits in Greek banks have fallen by about a third since the beginning of 2010.  Likewise deposits in Irish and more recently Spanish banks have also been falling.  Essentially, depositors shifted their money to ‘safer’ banking systems e.g. Germany.  Why?

Unlike the Great Depression, Eurozone’s bank run is caused by the fear of devaluation of their deposits relative to those in core economies if the euro were to break up.

Reference:  Financial Times, Gavyn Davies, “The anatomy of the Eurozone bank run"