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A poster for the 1896 Broadway melodrama The War of Wealth depicts a typical 19th century bank panic in the U.S.

A bank run (also known as a run on the bank) is a type of financial crisis. It is a panic which occurs when a large number of customers of a bank fear it is insolvent and withdraw their deposits.

A run on the bank begins when the public begins to suspect that a bank may become insolvent. As a result, individuals begin to withdraw their savings. This action can destabilize the bank to the point where it may in fact become insolvent. Banks retain only a fraction of their deposits as cash (see fractional-reserve banking): the remainder is issued as loans. As a result, no bank has enough reserves on hand to cope with more than the fraction of deposits being taken out at once. As a result, the bank faces bankruptcy, and will 'call in' the loans it has offered. This can cause the bank's debtors to face bankruptcy themselves, if the loan is invested in a plant or other items that cannot easily be sold.

If many or most banks suffer runs at the same time, then the resulting chain of bankruptcies can cause a long economic recession.

As a bank run progresses, it generates its own momentum. As more people withdraw their deposits, the likelihood of default increases, so other individuals have more incentive to withdraw their own deposits. For this reason, a bank run has much in common with the reflexive processes described by George Soros, amongst others. Another example of a reflexive process is economic bubble.

Contents

[hide] 1 History 2 Notable incidents 3 Theory 4 In fiction 5 Prevention 6 See also

7 References

[edit] History

The run on the Montreal City and District Savings Bank. The Mayor addressing the crowd. Printed in 1872 in the Canadian Illustrated News.

Bank runs first appeared as part of cycles of credit expansion and its subsequent contraction. In the 16th century onwards, English goldsmiths issuing promissory notes suffered severe failures due to bad harvests plummeting parts of the country into famine and unrest. Other examples are the Dutch Tulip manias (1634-1637), the British South Sea Bubble (1717-1719), the French Mississippi Company (1717-1720), "Post Napoleonic Depression" (1815-1830) and the Great Depression (1929-1939).

Bank runs have also been used to blackmail individuals or governments; for example in 1830 when the British Government under the Duke of Wellington overturned a majority government under the orders of the king, George IV, to prevent reform (the later 1832 Reform Act), he angered reformers and so a run on the banks was threatened under the rallying cry "To stop the Duke go for gold!".

[edit] Notable incidents

In 2001, during the Argentine economic crisis (1999-2002), a bank run and corralito was experienced in Argentina. There are various theories into the cause.[1] This contributed towards the bank runs in neighbouring Uruguay during the 2002 Uruguay banking crisis.

From 9 November to 12 November 2006, Nepal Bangladesh Bank Limited (NB bank) in Nepal suffered a bank run. On 8 November 2006, a Nepalese newspaper reported that NB Bank's 13 billion Nepalese rupees was at severe risk due to misuse of deposits by bank management. This news caused a run on the bank. Depositors withdrew around 3 billion Nepalese rupees during the three days of the run. However, after the takeover of bank management by the central bank of Nepal, the run ended.

In early August 2007, the American firm, Countrywide Financial suffered a bank run as a consequence of the subprime mortgage crisis.[2]

Northern Rock bank run on the morning of 14 September 2007.

On 13 September 2007, the British bank Northern Rock arranged (but did not use) an emergency loan facility from the Bank of England, which it claimed was the result of short-term liquidity problems (stemming from over-exposure to the failing US sub-prime mortgage market). A run began the following day, Friday, with reports of its internet banking site being overloaded,[3] and long queues outside branches that day, Saturday morning and the following Monday.[4] News reports on 17 September stated that an estimated £2 billion GBP of retail deposits had been withdrawn by customers since the bank had applied for emergency funds. [5] Later that day the Chancellor of the Exchequer, Alastair Darling, announced that the Treasury would guarantee all currently deposited savings held with Northern Rock, exceeding the pre-existing capped guarantee of £31,700 per depositor per institution offered by the Financial Services Compensation Scheme. This had the effect of ending the run.

The Governor of the Bank of England then injected £10bn into the financial system, to ease the liquidity problems of other banks, reducing the rates at which banks lend to each other from the high levels they had reached, and so stemming the crisis and avoiding runs on other banks.

The Treasury had previously declined to guarantee deposits held at Northern Rock, and the Bank of England had declined to inject liquidity into the financial system, at least in

part for fear that their support to troubled banks would cause a moral hazard, with banks taking greater risks in the future, in expectation of state rescue should the risks fail.

[edit] Theory

A famous model on bank runs was developed by Diamond and Dybvig.[6]

[edit] In fiction

In The Count of Monte Cristo the protagonist Edmond Dantes, in disguise as the fabulously wealthy Count of Monte Cristo, takes revenge on Danglars by withdrawing huge sums of money under a letter of credit from another bank which gives "unlimited credit". This, combined with rumours of insolvency, leads to the bank's collapse and disgrace for its founder Danglars.

In James Clavell's novel, Tai-Pan, a bank run nearly bankrupts the protagonist, Dirk Struan, and forms the basis of many events in the book.

In the Tom Swift series the eponymous hero uses his technology to stop a run on the bank.

In the 1964 movie Mary Poppins, the Banks children accidentally cause a bank run at their father's bank.

In one of the pivotal scenes of the movie It's a Wonderful Life, the hero George Bailey saves his building and loan association from a run by using the money from his wedding trousseau to supply cash to his panicked depositors.

In Arthur Hailey's 1975 novel The Money Changers, the hero narrowly prevents a bank run from bankrupting his bank after the revelation of a major fraud.

In the film Sneakers, it is discussed that one of the abilities of a code breaking device is to cause bank runs.

In the episode The PTA Disbands! of The Simpsons, Bart Simpson causes a bank run by inserting rumors about the bank's insolvency. This causes a Jimmy Stewart-like bank manager to say "I don't have your money here. It's at Bill's house and Fred's house!" referring to the bank run on It's a Wonderful Life.

In The Jungle, by Upton Sinclair, rumours of a bank run cause the character Marija to withdraw her savings. Later, it turns out that "the cause of the panic had been the attempt of a policeman to arrest a drunken man in a saloon next door, which had drawn a crowd at the hour the people were on their way to work, and so started the 'run'."

[edit] Prevention

Modern economies use several methods to prevent bank runs across the whole economy, while still allowing individual institutions to fail. (A system where no bank was ever allowed to fail would cause a moral hazard, and result in poor management of banks).

Deposit insurance systems (such as the Canadian Deposit Insurance Corporation in Canada) insure each depositer up to a certain amount, therefore the depositers' savings are protected even if the bank fails. This removes the incentive to withdraw your deposits simply because others are withdrawing theirs. (Note, though, that this works only if consumers trust the insurance system. When the Maryland, US state savings and loan system collapsed in 1985, the underfunded insurance system took more than a year to refund deposits to account-holders at the institutions that failed.)

Central banks act as a lender of last resort. To prevent a bank run, the Central Bank guarantees that it will make short-term, high-interest loans to banks, to ensure that, if they remain economically viable, they will always have enough liquidity to honour their deposits.

Reserve ratios and Tier 1 capital thresholds both limit the proportion of deposits which a bank can loan out. These methods help ensure that a bank does not have an unsustainably low level of reserves.

According to the World Economic Forum's Global Competitiveness Report, Canada and Australia are tied for the soundest banking systems in the world.

www.wikipedia.org

Definition: A bank run takes place when the customers of a bank fear that the bank will become insolvent. Customers rush to the bank to take out their money as quickly as possible to avoid losing it. Federal Deposit Insurance has ended the phenomenon of bank runs.

http://economics.about.com/library/glossary/bldef-bankrun.htm

Run on the bank

Patrick Hosking, Christine Seib, Marcus Leroux and Grainne Gilmore

The jitters plaguing financial markets spread to the high street for the first time yesterday as thousands of panicking savers queued to withdraw millions of pounds from Northern Rock, Britain’s eighth-biggest bank.

The rush to pull out savings followed the revelation that Northern Rock had been forced to ask the Bank of England for a rescue injection of finance.

As crowds of customers demanded their money back, shares in Northern Rock slumped by 31 per cent after it alerted shareholders to its difficulties, wiping £900 million from its value. Shares in other financial institutions were also hit, with Alliance & Leicester down 7 per cent and the specialist lender Paragon Group down 17 per cent.

The Bank of England pledged to provide unspecified liquidity support to see Northern Rock through the turbulence while it worked on an orderly resolution to its problems. The bank is braced for a fresh surge of withdrawals from its 76 branches to-day and last night was planning to extend its opening hours.

RELATED LINKS Panicked pensioners demand their money back

A (Northern) Rock and a Hard Place

What happened to Northern Rock?

Adam Applegarth, the chief executive, told The Times that he had ordered extra deliveries of cash in expectation of the deluge.

The nerves were exacerbated yesterday when Northern Rock’s computer system collapsed under the weight of online customers scrambling to transfer money out of the bank. Savers were blocked from seeing details of their accounts, including statements, when they tried to log in. A spokesman said accusations that the bank had shut down its system to prevent a drain on its finances were ridiculous.

Ministers, regulators and bankers tried to calm the panic by issuing reassuring statements that customers’ deposits were safe. The Financial Services Authority, which supervises banks, said that Northern Rock was solvent, exceeded its regulatory capital requirement and had a good-quality loan book.

Alistair Darling, the Chancellor, who authorised the rescue, said: “At the moment there is plenty of money in the system, the banks have got money . . . they are simply not lending in the short-term way that institutions like Northern Rock need.”

Sentiment soured further amid fresh evidence that house prices were starting to fall. Rightmove, the online property site, reported that asking prices slumped by 2.6 per cent last month. That followed a report by the Royal Institution of Chartered Surveyors showing the first fall in house prices in nearly two years.

Northern Rock customers fearing for their savings filled branches across the country, with some queues stretching down the street. At one London branch, customers queued for more than an hour. Wil-liam Gough, 75, said he did not believe the bank’s assurances that his savings were safe. “They’re telling us not to worry, but we’ve heard it before, with Marconi,” he said, referring to the collapse of the telecoms firm in 2002.

Another saver, Gary Diamond, said: “I don’t want to be the mug left without my savings.”

Another customer, an elderly woman, said that she could not afford to take any chances. “It’s my life savings we’re talking about, my pension. I’ll have nothing left if they go under.”

A retired hotelier and his wife barricaded the Cheltenham branch manager in her office after being told that they could not withdraw £1 million savings without notice. The situation was resolved only when police officers arrived to calm the couple down.

The British Bankers’ Association said: “Everyone should calm down and refrain from making simplistic comments in a very complex area which just causes unnecessary worry and concern. Northern Rock is a sound and safe bank and there is absolutely no reason for either mortgage customers or savers to worry.” It is the first time that the “lender of last resort” facility has been used since the Bank of England set up the present system in 1998. Other banks, including Barclays, have called on the Bank of England for overnight funding in recent weeks, but using the lender-of-last-resort facility is regarded as a much more serious step.

Sources at the Bank emphasised that Northern Rock would pay a penal rate of interest on any borrowings and would have to lodge assets as security.

Many financial institutions have been hit by a sudden shortage of cash and other liquid assets as banks hoard money in anticipation of having to provide finance to complex investment vehicles. Triggered initally by defaults by poor Americans struggling to meet increased mortgage bills, the problem has spread.

Northern Rock has been hit particularly badly because it relies much more on funding from wholesale investors, who have been paralysed by the credit crunch, rather than ordinary depositors. But it also risks being accused of overaggressive lending after lifting new loans by 43 per cent in the first eight months of 2007.

Around 85 per cent, or £24.7 billion, of Northern Rock’s business comes through mortgage brokers. National Savings & Investments, the govern-ment-backed savings institution, said that it saw a 20 per cent jump in the number of inquiries yesterday, the majority from Northern Rock savers.

Northern Rock has around £24 billion of customer deposits, though some of the money is locked up for months in long-term accounts. It said yesterday that it still expected to make an underlying profit of £500-540 million this year.

http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article2457009.ece