A bank run is one of those rare financial terms that’s exactly what it sounds like.
It literally starts with a crowd of people sprinting to the bank.
And while that may sound like a mere nuisance to bank tellers trying to go home at 5:30, even the smallest bank runs can have devastating consequences.
Bank runs have precipitated the Great Depression, collapsed modern banks, and even played a major role in modern warfare.
So what are bank runs? What should every young American investor know about them? Why are they so devastating, and should you ever join a bank run?
What is a bank run?
A bank run occurs when a large group of people all try to withdraw their cash from the bank at once. Since banks don’t carry that much cash, they must sell assets to meet demand, risking default. When they risk default, people panic even more and cause a bigger bank run.
Bank runs are nasty business, so let’s start with the basics.
Why would everyone rush to withdraw cash all at once?
People may rush to the bank to withdraw their cash for a variety of reasons:
- They’re afraid the bank will default.
- They’re afraid the economy is going to collapse.
- They’re trying to convert cash into goods or foreign currency to avoid inflation.
- They need cash to cross the border during wartime.
- They fear that a bank run will happen, and ironically cause the bank run.
OK, so there are a lot of reasons why folks might want their cash. But if you have $2,000 in a Chase checking account, why should Chase be scared or surprised if you actually go and take it?
Why bank runs are a big issue for banks
Let’s say that you have a net worth of $25,000:
- $5,000 in checking and savings.
- $10,000 in your 401(k) and other investments.
- $10,000 of equity in your car.
Suddenly, you get a surprise medical bill for $25,000.
Could you pay that bill?
Technically speaking, yes.
But net worth doesn’t mean cash on-hand. You have $5,000 in cash (effectively) and $20,000 in places that are much less accessible.
So to pay the bill, you’d have to empty your accounts, sell your car, and exit all of your investing positions in a short window of time.
- Even if you pulled it off and paid the bill in full, you’d be insolvent, which is basically the formal economic term for broke AF — no assets, savings, nada.
- When you’re unable to pay your next bill, you go into default.
- When you’re in default and falling behind on bills, you might declare bankruptcy to solicit legal help managing your debt.
That’s essentially what’s happening to a bank during a bank run; they’re forced to convert assets into cash, leaving them high and dry.
Let’s say a bank has $100 million total assets but only $5 million in cash.
- If clients try to withdraw just $10 million in cash in one day, that would force the bank to sell off some assets prematurely, reducing their solvency.
- Reduced solvency may lead clients and investors to worry that the bank will go into default.
- The fear of the bank defaulting makes more people want to withdraw their cash.
- The bank is now forced to sell off so many assets to meet cash demands that they now actually might go into default.
Are you starting to see why bank runs are widely considered a self-fulfilling prophecy?
It’s no wonder, then, that FDR opened his 1933 inauguration speech with the following choice words: “The only thing we have to fear is fear itself.”
Bank runs vs. silent bank runs vs. bank panics
In addition to bank runs, anyone considering themself fiscally savvy should know about silent runs and panics, too.
- Bank runs occur when people quite literally run to the bank to withdraw cash in-person.
- Silent bank runs occur when folks withdraw funds electronically, still effectively moving money out of the bank.
- Bank panics occur when multiple banks face bank runs at once, risking the collapse of an entire domestic economy.
That covers the basics of the term, so let’s layer in some context. Have we ever experienced a bank run?
Has the U.S. ever experienced a bank run?
We sure have, and I bet you’re a smart enough cookie to guess when.
When the stock market crashed in 1929, Americans started pulling their cash out of banks and literally stuffing it under their mattress to protect it.
And who could blame them? Back then, if your bank collapsed with your money inside, it was simply gone.
The mattress-stuffing strategy spread like wildfire, and when rumor spread that banks were barring folks from withdrawing money, it led to a full-on panic.
Throughout the early 1930s, folks sucked all the money out of the banks. The banks, in turn, had no money to loan, so the entire global economy ground to a halt.
By 1933, Congress desperately needed a way to get Americans to put their money back into the banks, so they came up with the Federal Deposit Insurance Corporation, or FDIC, which basically told them, “If your bank collapses, we got you.”
Today, the FDIC insures each of your bank accounts for up to $250,000.
Additional measures used to prevent bank runs include borrowing from other banks, limiting cash withdrawals, or even shutting down the bank entirely for a “holiday” until the panic subsides.
These measures weren’t quite enough to save Wachovia or Washington Mutual during the Recession, but they’ve still saved a lot of banks globally since 1933.
So that’s a bank run in a nutshell: people pull their cash out for a variety of reasons, the bank starts hurting, and news of the bank hurting causes more people to pull their cash out.
Now, if you’ve been monitoring current events lately, your fresh knowledge of bank runs might be raising another question:
Why did Russia experience a bank run — but not Ukraine?
A nuclear superpower invaded its neighbor, literally blowing up the banks, and yet the invader suffers a bank run.
Well, simply put, Ukraine was prepared and Russia wasn’t.
With the buildup of Russian troops on the border, Ukraine’s government knew they were facing the risk of a bank run. Therefore, they preemptively set up deals with Poland and the International Monetary Fund (IMF) to secure loans and stabilize the Ukrainian hryvnia.
On the night of the invasion, Zelensky also froze electronic transfers and only allowed each Ukrainian to withdraw roughly $3,400 USD in cash.
This amount of cash still required drivers to deliver cash under heavy fire, but the plan worked; Ukrainians were able to withdraw just enough cash to flee and relocate, and the economy survived.
Russians, on the other hand, are facing more dire economic circumstances.
The country’s central bank took some precautions to protect the ruble, but Western sanctions steamrolled over their economic defenses. Russia has been frozen out of their massive $643 billion foreign currency reserve, booted from SWIFT, and the ruble has fallen 40%.
As a result, Russians are (understandably) making bank runs nationwide, desperate to convert their rubles into something, anything that will hold its value: Victoria’s Secret bras, Bitcoin, even Big Macs.
The situation in Ukraine and Russia shows another side of bank runs: how in times of war, a foreign power can help you avoid a bank run — or, alternatively, trigger one as a weapon of war.
Take it from Sergey Aleksashenko, a former Russian central banker himself: “This is a kind of financial nuclear bomb that is falling on Russia.”
Granted, the ruble bounced back in early April thanks in part to oil and gas sales — but Russians are still quite wary that their situation remains bleak. Interest rates are 20%, inflation hit 200%, and the population is bracing for mass shortages of goods both foreign and domestic.
All this in a matter of weeks, which begs the question:
What should you do during a bank run?
Seeing long lines of normal Russians trying to preserve their livelihoods may make you wonder: Are they doing the right thing? And is there ever a time when I should sprint to the bank?
The short answer is no; you shouldn’t ever have to sprint to a U.S. bank, for a few reasons:
- Unlike the ruble, the dollar has been the world’s primary reserve currency since 1944, meaning it’s more stable and upheld by the global marketplace.
- With so many regs and safeguards in place, the probability of a modern American bank collapsing is significantly low.
- Even if your bank does collapse, your checking and savings accounts are insured for $250,000 each – and the FDIC has a history of paying out as promised (see: Wachovia, Washington Mutual).
Furthermore, should there ever be a bank run-worthy crisis in America, the Fed will react just like Zelensky: limit the amount of cash we can withdraw to a few thousand bucks so the economy keeps churning.
Even then, unless you’re traveling and/or have no access to electronic payments, it’s better to keep your money where it is.
Should I stash my money in crypto during a crisis?
During the next recession, would it be safer to store your money in crypto than the bank?
If you move your money from the bank into crypto, you’re moving it from a place where it is FDIC insured to a place where it isn’t.
Furthermore, crypto values are likely to drop during a recession since institutional investors tend to pull out of high-risk, speculative investments during economic turmoil — and pour capital into index funds and bonds instead.
But what about crypto as a hedge against inflation? After all, FDIC will only replace my lost dollars, not protect their value.
For a solid hedge against inflation —one that’s essentially guaranteed to protect your money, not unlike FDIC insurance — check out I Bonds.
The bottom line
Bank runs may sound innocuous — and even look a little ridiculous from the photos — but even the smallest bank runs can send banks and entire economies spiraling out of control.
Luckily, we don’t have to worry much about them in the U.S. anymore; but since they’re affecting other countries and playing a critical role in modern warfare, every young investor should know about them.
And while you shouldn’t need to sprint full tilt to a Chase ATM anytime soon, it wouldn’t hurt to have a little liquidity put aside. Here’s everything you need to know about emergency funds.
Featured image: 1000 Words/Shutterstock.com
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