How a bank run happens
A bank run is rational at the individual level and catastrophic at the collective level, which is why they are so hard to stop.
Understand why a solvent bank can be destroyed in 48 hours.
How a bank run happens works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
Why a solvent bank can die in 48 hours
The bank lent your deposit out. That is not a scandal, it is what a bank is. It only becomes fatal when everyone asks for their money on the same afternoon.
- 1
The bank does not have your money
It has lent most of it out, which is the entire point of a bank. Your deposit is repayable on demand; the loans it funded are not. That mismatch between what the bank owes today and what it can collect today is permanent and structural.
- 2
Which is fine, until everyone asks at once
Normally only a small fraction of depositors want their money on any given day, so the mismatch never bites. The system runs on the assumption that you will not all turn up together.
- 3
A rumour makes withdrawing rational
If you believe the bank may fail, the correct move is to withdraw immediately, because the money runs out and the last in the queue gets nothing. Crucially, this is true even if you think the rumour is probably false: what matters is whether others believe it.
This is the trap. Everyone acting sensibly produces the collapse that nobody wanted, and the belief becomes true because people acted on it.
- 4
Selling assets to pay out is what kills it
To meet withdrawals the bank must sell assets fast, which means selling at bad prices. Long bonds bought when rates were low are now worth far less. Losses that were theoretical become real, and a bank that was solvent on paper this morning is insolvent by the afternoon.
You can explain why deposit insurance exists, and what it is actually insuring against.
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A bank run is rational at the individual level and catastrophic at the collective level, which is why they are so hard to stop.
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