Nature of Bank Panics and Runs
by Syed Alamdar Ali
The inherent instability of banking systems has always been a matter of concern for policymakers. Before the great depression of 1930 in USA, the world witnessed recurrent episodes of banking panics, where depositors suddenly demanded conversion of deposits into cash at all or many banks, forcing banks to suspend convertibility. Since then, the common view is that governments must intervene to prevent or reduce the frequency of panics and a myriad of regulatory schemes have been implemented across many countries. In spite of the repeated attempts to stabilize banking systems, most countries experienced episodes of banking crises whose frequency and intensity increased in the last twenty years. A panic that encompasses a large part of the banking system can seriously disrupt economic activity. During a run, a bank experiences much heavier demand for deposit withdrawals than it can easily meet. If the run is severe enough, the bank will not be able to meet the demands of all depositors trying to withdraw money and, consequently, will have to suspend payments. During a panic, runs occur on a large number of banks. Panics may occur because of regional or economy wide problems, such as a real estate bust, during which the portfolios of many banks lose value. If depositors have not completely lost confidence in the banking system, they will transfer their deposits from failing banks to solvent banks. But panics may also occur because runs on a few banks cause depositors at other banks to lose confidence and, therefore, to withdraw indiscriminately from both solvent and insolvent banks. These types of panics, which involve runs on a few banks spreading to otherwise solvent banks, are said to involve contagion.
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