Bank Run and Its Effects on National Economy
A country’s economy is ultimately determined by the actions of its people. While news of company or government financial decisions easily affects the economy, there are situations wherein a collective action of its people can be devastating. When everyone does something at the same time, it could have some immediate positive or negative effects to the national economy. An example of a specific economic phenomenon that shows the power of consumer’s collective action is a bank run. It’s a simple action that can be regularly observed in various banks but devastating when done at the same time.
The simple action: withdraw the deposits.
This common action does not have devastating effects for banks on a regular basis but when clients withdraw their deposits at the same time, the bank can easily fold in just a few days. The resources the bank holds are depleted and they have to ask the government or larger financial entities for assistance to prevent bankruptcy. Since more money is coming out than going in, nothing will be left unless the bank receives some kind of assistance. It’s just a simple banking transaction and could happen in any day to any consumer but when the deposits are taken out at the same time and en masse, the effects are devastating.
Understanding Depletion of Resources
Banks are not supposed to run out of funds since they actually receive the money from their clients as deposits. But when a bank run happens, the resources could be depleted that some may not be able to withdraw their money as expected. This happens because the bank does not necessarily keep everything and lock the funds in the vault. They are allowed to take out the funds and use them for various investments they choose. But banks are not allowed to take out everything – they have to leave a certain percentage of the amount in the vault. The usual percentage is 10% which means for every $1,000 of deposit, the bank can use the $900 for investment and the rest should stay in the vault.
The idea that banks will run out of funds can happen. However, this doesn’t mean clients of the said banks will no longer access their hard earned money. The government has set-up an agency that protects the consumers from failing to access their funds. Through this agency, consumers can access their deposits even if their banks are closed. In US, the government has set-up the FDIC or Federal Deposit Insurance Corporation. Their work is primarily to monitor the banking activities around the country and aid clients of the said banks who undergo bankruptcy or insolvency. It was established in 1933 through the Glass-Steagall Act. As of this writing, each depositor of the member banks is insured up to $250,000 per bank.
Bank Run and the Snowball Effect
Bank run can happen anytime with or without any tangible reasons. What should be noted though is that this can happen when clients or consumers connected to the said bank starts to panic because of what they hear and see about the economy. Many will feel that something will happen economically and it’s not going to be beneficial to any consumer. Because of they are “feeling” something will happen, they panic and goes to their bank to withdraw everything. Once the news spreads about the panic, everyone else will have the same reaction. Sooner or later, people are lining up to get all their deposit out.
This phenomenon can also happen when people perceive that the system no longer works. There could be some trouble with the banking system that it gives out indicators that it can no longer hold the deposit of the consumers. Naturally, consumers will react by withdrawing their deposits.
As indicated, the indicators could be real or simply something created or perceived without any real evidence. In fact, pressing problems in the economy could be misinterpretation of information receive. But nevertheless, bank run can happen because there is panic. A good example is the “Panic of 1907” wherein people started to take out their funds from the bank because of latest news they receive on Wall Street. During that time, the country is already in recession but the worst part of recession only started when people started to panic because they through the stock market would crash.
Effects of Bank Run on National Economy
Banks are very important to the national economy. They do not only hold the consumer’s money for protection but they also provide considerable funding for various investments. Many of these companies have invested in various ventures so they generate jobs and generally push the economy further. They are also a big part determining the country’s financial stability as the deposits they receive is used as an indicator of the economic situation. Even their interest rates are used as indicators on the state of the country’s economy.
When bank run happens, everything else could collapse. Remember that banks in modern era are no longer just regular financial institution where money is securely placed. Other important financial transactions are taking place in banks. Even though consumers could still gain access of the funds they placed on the bank during insolvency, the fact that a bank is no longer available for other financial transactions.
A bank run is not just a phenomenon that indicates the country’s state of economy. It is an indicator that everyone is having trouble with the system and a drastic fix should be established to prevent additional problems.