Bank Runs

9 Key excerpts on "Bank Runs"

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  eBook - ePub

  Bank Runs and Systemic Risk

  • Edwin H. Neave(Author)
  • 2010(Publication Date)
  • Wiley

    (Publisher)

  3 were relatively rare. The difference in U.S. failure rates was attributed to both a changed environment and a stronger regulatory framework. However U.S. regulatory revisions did not prove adequate to the task, and another spate of nearly 250 failures occurred between the late 1980s and early 1990s. In yet another series of examples, Bank Runs and bank failures occurred in several Asian countries during the late 1990s. The problems began with individual banks, but eventually spread throughout the banking system and ultimately affected the creditworthiness of the countries themselves. Similarly, the credit crisis of 2007–2008 began with U.S. banks and U.S. investment banks, and later spread to financial institutions in many other parts of the world.

  Despite failures in many countries, however, banking instability is not universal. For example, Scotland has never had a bank run, although its banking history extends over more than 300 years, beginning with the formation of the Bank of Scotland in the late 1600s. Bank shareholders faced unlimited liability during the earlier years of Scottish banking history, but even after changing to limited liability ownership the Scottish banking system exhibited no instabilities. Similarly, Switzerland reports no Bank Runs over its lengthy banking history. At least part of the explanation for such differences appears to lie in countries' political differences. Both Allen and Gale (2007) and Rochet (2008) argue that political interference can play an important role in creating difficulties.

  A bank run is a loss of confidence in an individual bank, and can be a proximate cause of bank failure, although the fundamental reasons for bank failure are operating or loan losses.4

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  Unsettled Account

  The Evolution of Banking in the Industrialized World since 1800

  • Richard S. Grossman(Author)
  • 2010(Publication Date)
  • Princeton University Press

    (Publisher)

  As more depositors reach the same conclusion, panic withdrawals may spread through what Friedman and Schwartz (1963) characterize as a “contagion of fear.” Depositors and note holders might panic if an important asset or class of assets on the bank’s balance sheet were discovered to be of question-able value. For example, a bank that had made a large fraction of its loans to, or owned a large quantity of bonds of, a company that failed, or to an industry that suffered a severe downturn, could face a run. Simi-larly, a bank with substantial funds on deposit with a failing bank could be subject to a run. The discovery of large-scale losses due to fraud that was serious enough to erode a bank’s ability to redeem deposits could also lead to a run. Because banks have not always made their balance sheets and income statements public in a timely fashion, it is possible that depositors would not know of these developments until the prob-lems were so advanced that a run was likely, further encouraging them to withdraw their deposits at the slightest hint of trouble. Bank Runs can be precipitated by events having little to do with the con-dition of the bank itself. For example, the failure of a neighboring bank or the bankruptcy of a local but otherwise unrelated company might lead depositors to conclude that trouble is likely to spread to their bank and that their deposits are not safe. Since economic downturns are often accompanied by bank and business failures, these too could precipitate Bank Runs. And even if depositors were not worried about the safety of their deposits, they might worry about the value of those deposits. For example, concerns that a devaluation (or a substantial depreciation of a floating exchange rate) was imminent might lead depositors to make large withdrawals in order to convert their holdings into another—more stable—currency.

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  Global Bank Regulation

  Principles and Policies

  • Heidi Mandanis Schooner, Michael W. Taylor(Authors)
  • 2009(Publication Date)
  • Academic Press

    (Publisher)

  Like commuters who will enjoy clear roads if almost everyone else takes the train, bank depositors will have instant access to their cash as long as other depositors are content to leave their money in the bank. However, the moment that a person suspects that a larger number of depositors than normal will ask for their money back, and therefore the bank may lack the cash to meet all of their demands, that person’s rational response should be to rush to the bank ahead of every one else to make sure that he or she gets repaid. It’s like the commuter who reasons “Why shouldn’t I enjoy the comforts of my car if every one else is?” Every other depositor will think in the same way, and thus the run on the bank can become self-fulfilling. Thus, each and every depositor has a strong incentive to be first in the queue, and the risk that others may withdraw can cause a panic regardless of the underlying financial position of the bank. Bank Runs are thus caused by a shift in depositors’ expectations, which could depend on almost anything, including the apparently irrational behavior of seeing other people running on banks. Such a shift in expectations may result from “a random earnings report, a commonly observed run at some other bank, a negative government forecast, or even sunspots” (Diamond and Dybvig, 1983, p. 410). Deposit runs on banks therefore arise as the result of a coordination problem among depositors. If all depositors try to redeem their deposits at the same time, a bank will fail. The coordination problem is made worse, of course, if we also assume that the depositors have incomplete information. As discussed earlier, bank assets are difficult to value. Usually, they are not traded in secondary markets, which means that they do not have a market price. Moreover, the value of a bank loan can only really be assessed with the possession of very specific information that is available only to the bank and its borrowers, not third parties

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  Contagion of Bank Failures (RLE Banking & Finance)

  The Relation to Deposit Insurance and Information

  • Sangkyun Park(Author)
  • 2014(Publication Date)
  • Routledge

    (Publisher)

  This study highlights the contagion of bank failures as the major problem, and recognizes the scarcity of bank-specific information as its cause. This clarification enables us to view the stability of the competitive banking system from a different standpoint. The first significant factor is our ability to identify the cause of runs on solvent banks. It is presumably easier to eliminate a known cause of a problem than to deal with a “mysterious” phenomenon. Secondly, the main variable determining depositors’ behavior is one basically under the control of banks, namely, the solvency of banks. These findings modify the idea that competitive banking is inherently unstable due to banks’ inability to prevent runs. Bank Runs are not a matter that is completely out of the banks’ control. In addition, grasping the nature of the problem should enhance the analyses of bank panics and other issues surrounding it.

  NOTES

  1. Smith, Adam, An Inquiry into the Nature and Causes of the Wealth of Nation, Reprinted in 1976 by the University of Chicago Press, Chicago, 1776, Volume 1, p.319.

  2. “Against such panics, Banks have no security, on any system; from their very nature they are subject to them, as at no time can there be in a bank, or in a country, so much specie or bullion as the monied individuals of such country have a right to demand.” Ricardo, David, On the Principles of Political Economy and Taxation, Reprinted in 1951 by Cambridge university Press, Cambridge, 1817, pp.358, 359.

  3. Ricardo (see n.2), p.359.

  4. “The landing of a French frigate in one of the Welsh harbors and orders from the government to the farmers to drive their stocks into the interior, caused a run upon the Bank Of England [in 1797] which finally brought the long dreaded catastrophe of suspension of payment in coin.” Conant, Charles F., A History of Modern Banks of Issue, Fourth Edition, The Knickerbocker Press, New York and London, 1915, p. 98. Such an unfavorable situation of the war with France should be enough to impair the confidence in the British government and creditworthiness of the Bank of England.

  5. Kindleberger, Charles P., Manias, Panics and Crashes, Basic Books Inc., New York, 1978, Chap.3.

  6. Diamond, Douglas and Dybvig, Philip, “Bank Runs, Deposit Insurance, and Liquidity,” Journal of Political Economy, 1983.

  7. Diamond and Dybvig (see n.6), p.404.

  8. Chari, V. and Jagannathan, Ravi, “Banking Panics, Information, and Rational Expectations Equilibrium”, Journal of Finance,

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  A Global History of the Financial Crash of 2007–10

  • Johan A. Lybeck(Author)
  • 2011(Publication Date)
  • Cambridge University Press

    (Publisher)

  27 “Bank Runs” and deposit insurance Liquidity is the access to liquid, risk-free, short-term funding, as well as the ability to sell assets at or close to their nominal value. Solidity is the access to long-term, risk-bearing capital. As we shall see in the next chapter, it was not primarily lacking solvency that felled or threatened to fell a number of banks in the USA in the present crisis, but lacking liquidity. One of the banks’ major roles on the financial markets is to function as transformers of maturity. Borrowers seek the safety of long- term loans with fixed rates of interest. In the USA, 15- to 30-year fixed rate mortgages remain the most common type of mortgage lending in the prime market. 28 Depositors want flexibility and the ability to withdraw their funds without notice. This situation creates a natural conflict of interest and a risk, which must be managed by the supervisory authorities prescribing a certain minimum relationship between a bank’s short-term assets and short-term liabilities. But just as important is the ability for a bank subjected to abnormally large withdrawals of depositors’ money to be able to access liquidity from other banks or from the central bank. Depositors are well aware of the fact that bank reserves only cover a fraction of their short-term liabilities (fractional reserve banking). A rumor doubting a bank’s solidity and long-term capability of survival will lead to rational people trying to withdraw their deposits. 29 The first known example of such a “bank run” occurred in Sweden in 1668. The Palmstruch Bank (also called Stockholm Banco) had pioneered the 27 Bernanke et al., Inflation Targeting. 28 One of the problems with subprime loans, as we saw earlier (pages 129ff.), was that not only was their credit quality lower, but they generally had a variable rate of interest, adjustable rate mortgages. 29 The classic article on why Bank Runs occur remains Diamond and Dybvig, Bank Runs, deposit insurance and liquidity.

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  The Banking Crisis Handbook

  • Greg N Gregoriou(Author)
  • 2009(Publication Date)
  • CRC Press

    (Publisher)

  502 ◾ The Banking Crisis Handbook Selvaretnam, G. (2007) Regulation of reserves and interest rates in a model of Bank Runs. Working Paper CDMA07/14, University of St Andrews, Scotland, U.K. Available at SSRN: http://ssrn.com/bstrct=1015234. Schotter, A. and Yorulmazer, T. (2008) On the dynamics and severity of Bank Runs: An experimental study. Available at SSRN: http://ssrn.com/abstract=1090938. Schumacher, L. (2000) Bank Runs and currency run in a system without a safety net: Argentina and the “Tequila” shock. Journal of Monetary Economics , 46: 257–277. Tchankova, L. (2002) Risk identification—Basic stage in risk management. Environmental Management and Health , 13(3): 290–297. Télévision Suisse Romande (2008), Les banques Raiffeisen sont en verve, News July 6, 2008, http://www.tsr.ch. Wheelock, D. C. and Wilson P. W. (1995) Explaining bank failures: Deposit insur-ance, regulation, and effi ciency. The Review of Economics and Statistics , 77(4): 689–700. Yokoyama, K. (2007) Too big to fail: The panic of 1927. Working Paper No. 465, Nagoya City University, Japan. Available at SSRN: http://ssrn.com/ abstract=980879. Yorulmazer, T. (2008) Liquidity, Bank Runs and bailouts: Spillover effects during the northern rock episode. Available at SSRN: http://ssrn.com/abstract=1107570. Zhu, H. (2001) Bank Runs without self-fulfilling prophecies. BIS Working Paper No. 106. Available at SSRN: http://ssrn.com/abstract=847445.

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  Systemic Implications Of Transatlantic Regulatory Cooperation And Competition

  • Robert M Stern, Simon J Evenett(Authors)
  • 2011(Publication Date)
  • World Scientific

    (Publisher)

  1 Banks are in the business of borrowing short and lending long. In doing so they provide an essential service 1 A very useful book is Goodhart and Illing, (2002). 23 24 P. De Grauwe to the rest of us, i.e., they create credit that allows the real economy to grow and expand. This credit creation service, however, is based on an inherent fragility of the banking system. If depositors are gripped by a collective movement of distrust and decide to withdraw their deposits at the same time, banks are unable to satisfy these withdrawals as their assets are illiquid. A liquidity crisis erupts. In normal times, when people have confidence in the banks, these crises do not occur. But confidence can quickly disappear, for example, when one or more banks experience a solvency problem due to non-performing loans. Then, Bank Runs are possible. A liquidity crisis erupts that can also bring down sound banks. The latter become innocent bystanders that are hit in the same way as the insolvent banks by the collective movement of distrust. The problem does not end here. A devilish interaction between liq-uidity crisis and solvency crisis is set in motion. Sound banks that are hit by deposit withdrawals have to sell assets to confront these with-drawals. The ensuing fire sales lead to declines in asset prices, reduc-ing the value of banks’ assets. This in turn erodes the equity base of the banks and leads to a solvency problem. The cycle can start again: the solvency problem of these banks ignites a new liquidity crisis and so on. The last great banking crisis occurred in the 1930s. Its effects were devastating for the real economy. After that crisis the banking system was fundamentally reformed. These reforms were intended to make such a banking crisis impossible. The reforms had three essential ingre-dients. First, the central bank took on the responsibility of being the lender of last resort. Second, deposit insurance mechanisms were insti-tuted.

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  Preventing the Next Financial Crisis

  • Victor A. Beker(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  Runs are a possibility every time illiquid assets are turned into liquid assets. But this is precisely the main function that banks and other financial institutions fulfill and that is why they are exposed to deposit runs or, in general, to an inability to access the debt markets for new funding. The inability to roll over debt through new securities issuances has a similar effect for non-banks to deposit withdrawals for banks.

  That’s why Cochrane (2014) proposes a run-free financial system by eliminating run-prone securities from it. In his view, demand deposits, fixed-value money market funds or overnight debt must be backed entirely by short-term government debts. Banks should be 100% equity-financed which means they cannot fail because they have no debt. Of course, these banks don’t have money to lend but, according to Cochrane, today’s technology makes sure this can’t be a problem.

  But in today’s real world there is still a plethora of run-prone assets.

  Bao et al. (2015) define “runnables” as “pay-on-demand” transactions which embed defaultable promises made by private agents or state and local governments without explicit insurance from the federal government.

  In general, the pay-on-demand feature implies that in the event of stress – caused by credit-risk concerns, large swings in short-term interest rates, or deteriorations in market liquidity – investors may exhibit bank-run-like behavior by redeeming their shares, unwinding their transactions, or deciding not to roll over their positions.

  (Bao et al., 2015)

  The ultimate reason for runs is liquidity mismatch between assets and liabilities. This is a necessary but not a sufficient condition. The other feature which makes runnable a contract is that it promises fixed values payable in full on demand on a first-come first-served basis (Cochrane, 2014: 197). For example, if I know that the withdrawal of my non-insured deposits depends on the liquidity of long-term assets held by the bank and I hear that some people are withdrawing their deposits I will rush to withdraw my money before the bank’s assets become completely illiquid. Other people will do the same and this will set in motion a bank run. Notice that the bank’s ability to pay back deposits depends in the first place on the liquidity, not only the value, of its assets. A bank can be solvent, holding assets exceeding its liabilities under normal economic circumstances, but illiquid and therefore unable to pay back its deposits. That is why Bank Runs may be self-fulfilling prophecies and even “healthy” banks can fail.

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  Handbook of Macroeconomics

  • John B. Taylor, Harald Uhlig(Authors)
  • 2016(Publication Date)
  • North Holland

    (Publisher)

  J. Money Credit Bank. 42 (6), 3 – 35. 1423 Wholesale Banking and Bank Runs in Macroeconomic Modeling of Financial Crises Dang, T., Gorton, G., Holmstrom, B., 2012. Ignorance, debt and financial crises. Diamond, D., Dybvig, P., 1983. Bank Runs, deposit insurance, and liquidity. J. Polit. Econ. 91, 401 – 419. Di Tella, S., 2014. Uncertainty shocks and balance sheet recessions. Working Paper . Eggertsson, G., Krugman, P., 2012. Debt, Deleveraging, and Liquidity Trap: a Fisher-Minsky-Koo Approach, Q. J. Econ. 127 (3), 1469 – 1513. Ennis, H., Keister, T., 2003. Economic growth, liquidity, and Bank Runs. J. Econ. Theory 109, 220 – 245. Farhi, E., Tirole, J., 2012. Collective moral hazard, maturity mismatch and systemic bailouts. Am. Econ. Rev. 102 (1), 60 – 93. Farhi, E., Werning, I., 2015. A theory of macroprudential policies in the presence of nominal rigidities. Working Paper . Farmer, R., 1999. The Macroeconomics of Self-Fulfilling Prophecies. MIT Press. Ferrante, F., 2015a. A model of endogenous loan quality and the collapse of the shadow banking system. Finance and Economics Discussion Series 2015-021, Federal Reserve Board . Ferrante, F., 2015b. Risky mortgages, bank leverage and credit policy. Working Paper . Garleanu, N., Panageas, S., Yu, J., 2015. Financial entanglement: a theory of incomplete integration, leverage, crashes and contagion. Am. Econ. Rev. 105 (7), 1979 – 2010. Geanakoplos, J., Polemarchakis, H., 1986. Existence, regularity, and constrained suboptimality of com-petitive allocations when the asset market is incomplete. In: Uncertainty, Information, and Commu-nication: Essays in Honor of K. J. Arrow, III. Cambridge University Press, Cambridge. Gertler, M., Karadi, P., 2011. A model of unconventional monetary policy. J. Monet. Econ. 58 (1), 17 – 34. Gertler, M., Kiyotaki, N., 2011. Financial Intermediation and Credit Policy in Business Cycle Analysis. In: Friedman, B.M., Woodford, M. (Eds.), Handbook of Monetary Economics, vol.

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