Difference between Bank Run and Bank Panic


Can you think back to the Great Depression, which hit the international economy hard in the 1930s? That's true, the world−shaking financial collapse hit practically every country that makes things and grows food. Between 1929 and 1933, the amount of money in circulation decreased by an incredible 28%, leading to a wave of bank runs and the closure of banks and other financial institutions. The stock market crash was the initial catalyst, but simultaneous bank runs contributed significantly. So, the million−dollar question is− what precisely is a bank run? This raises the issue, "What are bank panics, and what is the relationship between them?" Okay, let's have a look.

What is Bank Run?

Banks spend their days trying to ensure they have enough cash on hand to cover the withdrawal requests they get from consumers. Since the bank only uses a fraction of its demandable deposits to pay its long−term loans and holds just enough reserves to insure its depositors, this number is often much smaller than the total deposits. That's why it's not even close to being as high as the total deposits. However, the financial system is still vulnerable, especially commercial banks that use the fractional−reserve banking system. As a result, a "bank panic" occurs when many depositors want to withdraw their money all at once from the same bank, and the bank is unable to meet everyone's demands.

Depositors rush to the banks to withdraw their money in a coordinated effort, fearing that the financial institutions would fail and lose faith in them in the process. Because of this, bank branches are closing their doors indefinitely. A "bank run" occurs when depositors suddenly lose trust in the banking system or worry that their individual bank could go out of business.

What is Bank Panic?

When a significant number of financial institutions experience simultaneous runs, this is known as a "bank panic." This occurs when depositors withdraw their money from banks because of fear that the institutions will be unable to pay their debt obligations. Banks are forced to liquidate their assets, a costly and time−consuming operation, so they can meet the demands of their clients making withdrawals. The banking system's panic occurs when unforeseen events make depositors nervous and put their funds at risk. When consumers are scared to make arbitrary withdrawals of their savings and run the risk of being unable to withdraw cash from their banks, a dangerous and unpredictable event known as a bank run ensues. Bank panics are the result of such concern.

Financial instability requires a dynamic environment, although economic downturns are not necessarily accompanied by banking panics. There is a decrease in the repayment rate of bank loans during economic downturns because more businesses fail during this time. A bank with an abnormally large number of bad loans would be in deep trouble, and if depositors saw any signs that this was likely to happen, the bank may be subject to a run. As a result, bank runs can trigger panic and worsen the nation's financial situation.

Differences: Bank Run and Bank Panic

The following table highlights how a Bank Run is different from a Bank Panic −

Characteristics Bank Run Bank Panic
Meaning When a large number of customers attempt to withdraw cash at once from a bank, this is known as a "bank run," which occurs when the bank is unable to deliver enough cash to meet customer demand. A "bank panic" occurs when a large number of banks experience simultaneous "runs," or mass withdrawals of depositors' funds.
Cause A "bank run" occurs when depositors suddenly lose trust in the banking system or worry that their bank could go out of business. The banking system's panic occurs when unforeseen events make depositors nervous and put their funds at risk.
Effect Reduced public confidence in the banking sector causes a drying up of available capital. The sudden and drastic reduction in accessible funds has the potential to trigger a catastrophic slump in the economy.

Conclusion

Bank runs not only cause sudden and unanticipated disruptions in the financial system, but they also make it more difficult to control the flow of money, which might potentially cause a severe economic downturn. Since financial institutions only keep a fraction of their deposits on hand at any given moment, they can't meet the withdrawal needs of all their customers simultaneously.

A bank can go bankrupt quickly even if it is solvent, meaning that its assets are worth more than its liabilities if a sudden surge in demand for withdrawals causes the bank to run dry of cash. Until some of the money that was borrowed from them is paid back, the financial institutions have little choice but to close their doors and refuse to do business until a lender, such as the Federal Reserve, gives some emergency funds to pay off the depositors.

Updated on: 25-Nov-2022

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