A bank run is a chaotic event where a large number of depositors, fearing that their bank is on the verge of collapse, all rush to withdraw their money at the same time.
This creates a problem because banks operate on a fractional reserve system, meaning they don’t keep all of their deposits in cash on hand. Instead, they lend out a majority of that money to borrowers or invest it in other assets.
When a run occurs, the bank may not have enough liquid assets to meet the withdrawal demands, even if it is fundamentally solvent.
How Do Bank Runs Happen?
The idea that “bank runs are contagious” is a core concept in understanding financial crises. This contagion can spread through several channels:
- Loss of Confidence and Panic: The primary driver of contagion is a loss of confidence. When a run begins at one bank, it can trigger a domino effect. Depositors at other banks, seeing what is happening, may fear that their own bank is next to fail, even if there is no real reason to believe so. This fear leads them to withdraw their funds, which can, in turn, cause a run on a previously healthy institution. The spread of information, especially in the modern age of social media, can accelerate this panic and make runs more rapid.
- Interconnectedness of the Banking System: Banks are not isolated entities. They are deeply connected through interbank lending, asset holdings, and other financial relationships. If one bank fails, it can create a ripple effect. For example, if Bank A has lent a significant amount of money to Bank B, and Bank B fails, Bank A could face a substantial loss, potentially triggering a run on its own deposits. This “domino effect” can undermine the entire financial system.
- Common Shocks: Contagion can also occur when a widespread economic shock affects multiple banks at the same time. For instance, a housing market crash or a stock market downturn could cause the value of assets held by many banks to plummet. This would put pressure on all of those banks simultaneously, making them all vulnerable to a run.
Historical Examples of Contagious Bank Runs
History is filled with examples that demonstrate the contagious nature of bank runs:
- The Great Depression (1929-1933): The stock market crash of 1929 triggered widespread panic and a series of bank runs. Fear and a lack of deposit insurance at the time led to a cascade of bank failures. As one bank failed, it fueled panic and runs on others, ultimately leading to the collapse of thousands of institutions and a severe contraction of the money supply.
- The 2008 Financial Crisis: While not a classic “queue-at-the-bank” scenario, the crisis demonstrated a modern form of contagion. The failure of large institutions like Lehman Brothers and the near-collapse of others like Bear Stearns sent shockwaves through the interconnected financial system. The lack of confidence spread rapidly, causing a freeze in the interbank lending market and requiring massive government bailouts to prevent a total systemic collapse.
- Recent Bank Failures (2023): The failures of Silicon Valley Bank (SVB) and Signature Bank in 2023 were classic examples of modern, digitally-accelerated bank runs. Rumors and concerns about the banks’ financial health, particularly their vulnerability to rising interest rates, spread quickly through social media and online channels. This led to a massive and rapid withdrawal of deposits, overwhelming the banks in a matter of hours and days and causing fear to spread to other regional banks.