You know the scene? It's a staple of dramatic
cinema. Oh, yeah. The cobblestone street, the
towering granite facade of some huge financial
institution, and just the sheer panic visible
in the crowds. Right. People are shouting. Their
faces are just etched with fear. They're clutching
their bank books like life rafts. And there's
this cue that just snakes out the door and around
the corner. And that line, that chaotic line,
it's not just about money, is it? No. It's the
physical manifestation. Of trust being revoked
institution by institution. It's fear made visible.
That image perfectly encapsulates the bank run.
It's this phenomenon that has played out for
centuries. It's where cold economic reality just
slams headlong into mass human psychology. Yeah.
And it proves that fear is. maybe the single
greatest destabilizing force in finance. OK,
so let's unpack this because we've synthesized
a fantastic, I mean, a really detailed body of
sources that breaks down this critical concept.
We're starting from the underlying architecture
of fractional reserve banking that makes banks,
well, inherently vulnerable. And we're going
all the way up to the very modern lightning fast
threats posed by cyber failures. And our mission
today. is to go beyond that simple definition.
We need to understand not just what a mass withdrawal
event is, but why. Why the belief that a bank
might fail is so uniquely capable of becoming
a self -fulfilling prophecy. We'll trace the
history. We'll delve deep into the core economic
models that explain the panic. We'll quantify
the massive societal costs involved and see how
the digital age is completely redefining the
speed and the nature of failure. And the core
definition is where that inherent fragility begins.
It is. A bank run happens when many clients all
at once withdraw cash from their deposit accounts
because they suspect the institution is or might
soon become insolvent. And the action itself
is fundamentally enabled by the fraction. reserve
banking system. Yeah. That's the critical starting
point. Explain that for us. Well, in the system,
the bank only keeps a fraction, a really, really
small proportion of its deposits as physical
cash reserves. OK. The rest is lent out. It's
working in the economy. So if a sufficient number
of depositors demand their money back at the
same time, the bank simply cannot meet those
demands from its reserves. It's not there. It's
not there. It forces them to try and liquidate
long -term assets, sell off loans, and they have
to do it at fire sale prices. And that triggers
the very failure they were afraid of. Exactly.
Now, if the funds are just transferred electronically
to another safer bank, the event is often characterized
as capital flight. Got it. But the effect on
the failing institution is, at the end of the
day, the same. A severe, sudden liquidity crisis.
When we read about market turmoil, you hear these
three terms, run, panic, crisis, and they get
tossed around almost interchangeably. All the
time. But our source material is very clear that
they represent a distinct, escalating scale of
financial distress. So I think it's important
for us to define this hierarchy of doom. based
on how broadly the contagion spreads? Absolutely.
The smallest unit is the bank run, which we just
defined. It's localized. So one institution.
Exactly. It affects a single financial institution.
For instance, if you hear a rumor that your local
credit union is underwater and you move your
funds to a big national chain, that's a run on
the credit union. And while that's damaging for
them, the whole system doesn't collapse. No,
the broader system can often absorb it without
any serious incident. But the moment that fear
jumps the fence. That's when we enter the territory
of a banking panic or a bank panic. This is a
much broader crisis. This is where many banks,
often across a wide geographic area or an interconnected
system, suffer simultaneous runs. And this happens
because people are losing faith, not in just
one bad actor, but in the whole setup. The whole
financial architecture. People aren't just moving
funds from bank A to bank B anymore. Right. They
are collectively trying to convert. their threatened
deposits into the safest possible asset, physical
cash. Or get out completely. Or they're trying
to exit the domestic banking system entirely,
you know, moving capital offshore if they can.
It's a mass flight to quality and it's driven
by a really deep -seated distrust. And then the
apex of this disaster, the most severe level,
is the systemic banking crisis. What defines
this level is just the sheer scope of it. We're
talking about almost all or all of the banking
capital in an entire country being essentially
wiped out or frozen. When you reach that level,
the cascading failure is devastating. I mean,
truly devastating. Why? Because the entire mechanism
that translates savings into productive investment
just seizes up. It starves domestic businesses
and consumers of capital. So no loans for inventory
for a small business. No mortgages for families.
No investment in new machinery for factories.
This inevitably, and I mean inevitably, leads
to a long, painful, and deep economic recession.
And this is where it gets really fascinating,
and frankly, a little terrifying, when we step
back and actually quantify the sheer scale of
the damage. It's staggering. We aren't talking
about small market fluctuations here. We're talking
about losses that cripple national economies
for years. The data available from comprehensive
analyses of systemically important crises between
1970 and 2007, it paints a really grim picture
of the aftermath. Let's start with the fiscal
costs. Okay. So fiscal costs, that means the
government money, taxpayer money necessary for
the cleanup. The bailouts. The bailouts, the
nationalizations, the restructuring, the guarantees.
On average, those costs hit 13 % of the country's
gross domestic product. 13 % of GDP. To put that
in perspective for you, that is a massive amount
of public debt or wealth transfer necessary just
to stabilize the banks that failed. And that's
just the public bill for the cleanup. The actual
economic output lost due to the freezing of credit
and investment is even more staggering. It's
much worse. The sources show that economic output
losses average approximately 20 % of GDP during
the first four years alone of these crises. 20%.
A fifth of a nation's entire economic output.
Gone. In the space of four years, it simply evaporates.
And it's not just a momentary contraction. It's
a sustained... years -long contraction, fewer
jobs, less technological development, and lower
standards of living for a generation. When you
consider that level of macroeconomic destruction,
you really start to understand the fierce urgency
with which individual banks operate when they
sense even the initial signs of trouble. That
leads perfectly into the bank's immediate mitigation
strategies. So you're a bank manager. You see
the first rumblings of a run. What are the first
desperate steps you take to survive that liquidity
squeeze? The very first step is to frantically
acquire cash. You have to prove you have the
physical ability to meet withdrawals. So you
start calling other banks. Immediately. You tap
your lines of credit with other commercial banks.
When that dries up, your ultimate lifeline is
the central bank, which acts as the lender of
last resort. Getting that emergency liquidity
is job number one. And at the same time, you're
trying to manage the flow of money going out
the door. You can't stop it, but you can slow
it down. Exactly. You might limit customer withdrawal
amounts, imposing hard cash limits per day. or
you might institute scheduling. What does that
mean, scheduling? If you can't get cash immediately,
you schedule deliveries quickly to maintain the
appearance of liquidity. You tell the customer,
come back in an hour. So you're managing expectations.
You're managing expectations, and you're preventing
the line from turning into a riot. And internally,
you're also trying to change the nature of your
existing liabilities. You pivot aggressively
toward encouraging high return term deposits.
It's a really smart, incentivized strategy. They
offer much higher interest rates to convince
clients to move their liquid demand deposits,
you know, the money they can take out instantly,
into fixed term accounts that can't be withdrawn
for 3, 6, or 12 months. So you're locking the
money down. You are immediately reducing the
bank's exposure to on -demand withdrawals. You're
turning your most dangerous short -term liabilities
into less risky long -term liabilities. And if
all of that fails, what's the nuclear option
for an individual bank? The temporary suspension
of withdrawals. Historically, it was called a
suspension of convertibility. You just shut the
doors. You freeze the situation. You halt the
run entirely. Now, while it restores order by
imposing a stop, it is a monumental signal of
distress. A huge red flag. A huge red flag. And
it usually requires government or regulatory
sanction. But for a desperate bank, it can be
the only way to avoid immediate bankruptcy. OK,
we've established the chaos a bank run causes.
But to really understand why this phenomenon
is so central to finance. We have to look past
the panic and deep into the underlying design
of banking itself. Right. The fractional reserve
system. Why is this model, which is so critical
for economic growth, so inherently fragile? The
inherent vulnerability really stems from the
fundamental service that banks provide to the
economy. Which is what? They accept demand deposits.
That's money that you, the depositor, need to
be liquid and instantly accessible. But if the
bank just sat on that cash, it would provide
no economic benefit. It would just be a vault.
So they invest it. They invest the majority of
those deposits into productive but illiquid assets.
And this creates the structural contradiction
that every single bank lives with, which is the
asset liability mismatch. Precisely. The bank's
liabilities, your deposits, are highly liquid.
They have the shortest possible maturity on demand.
Right now. Right now. But the assets the bank
holds are typically long -term loans. Think of
the 30 -year mortgage. The five -year car loan
or the massive 10 -year credit line to a manufacturing
company that's building a new plant. These are
long maturity assets. So the bank has successfully
created liquidity out of illiquidity. That's
its core function. It is. But it means that by
design, no bank has enough immediate reserves
to handle simultaneous withdrawal demands from
all its liquid deposits. Just can't be done.
So the system works perfectly only as long as
people behave in an uncorrelated fashion. Exactly.
Which brings us to the foundational economic
theory explaining this mechanism, the Diamond
-Dibvig model. This model, developed by Douglas
Diamond and Philip Dibvig, is maybe the single
most influential explanation for bank runs. It
elegantly shows the bank acting as a risk -sharing
intermediary. How so? It satisfies two groups,
those borrowers who need long maturity loans
and those depositors who need immediate liquidity.
The bank efficiently pools the resources of these
different types of customers. And the model introduces
two critical types of depositors, right? The
patient ones and the impatient ones. Exactly.
The impatient depositors are those who experience
an unexpected immediate need for cash, maybe
a medical emergency or a sudden tuition payment.
Life happens. Life happens. They need to withdraw
early. The patient depositors are those who don't
face an immediate shock. They can afford to wait
and receive the full long -term return on their
investment. And the genius of the bank is what?
The genius is that through the law of large numbers,
it can successfully predict the aggregate need
for cash. It services the impatient customers
while keeping the rest of the money invested
for the patient customers. So stability relies
on that prediction holding true. The moment that
assumption, that assumption of uncorrelated behavior
is shattered, the whole system just flips. And
that's where the concept of the self -fulfilling
prophecy kicks in. Right. What's fascinating
here is that the run doesn't even require the
bank to be fundamentally insolvent based on its
assets. It can be a perfectly good bank. It can.
A run can start merely from a false rumor or
simply a perceived risk in the general economic
climate. And crucially, depositors who might
even know the bank is solvent and the rumor is
false still have a powerful, completely rational
incentive to withdraw their money if they suspect
that other depositors will believe the rumor
and withdraw theirs. So your decision to participate
in the panic isn't about your personal assessment
of the bank's health. No. It's about your assessment
of the crowd's irrationality. You're withdrawing
your money not because you know the bank is dead,
but because you know if everyone else acts as
if it is, you will lose access to your money.
your cash. This is a perfect example of the self
-fulfilling prophecy, a term coined by the sociologist
Robert K. Merton, who specifically cited bank
runs in his work. I didn't know that. Oh, yeah.
The expectation of a negative outcome creates
the very conditions necessary for that negative
outcome to occur. This brings us squarely into
the realm of game theory, specifically the concept
of the Nash equilibrium, as noted by former Bank
of England governor Mervyn King. Yes, you have
two equilibria. The good one, which is stability,
and the bad one, which is the run. Okay. The
good equilibrium is stable. Nobody withdraws.
The bank is stable, and everyone gets the full
return on their money. The bad equilibrium is
also stable. Kay observed that while it may not
be rational for any single person to start a
bank run. Right. Why would you? Once the run
has begun, once that collective action has started.
it becomes entirely rational for you to participate.
Why is participation so rational? I mean, break
that down. Because the bank has a limited amount
of cash. Yeah. If you wait, you risk being the
last one in line when the cash runs out. And
at that point... At that point, the bank is forced
into a fire sale of its long -term assets, selling
loans or securities way below market value, which
causes losses for everyone who's still in. And
if it fails completely? You lose all or part
of your deposit, unless you're insured. Therefore,
your only rational, self -protective move is
to join the panic. Secure your money before the
collective action bankrupts the institution.
So the individual rational choice aggregates
into a disastrous, systemically irrational outcome.
That's the tragedy of it. The theory is modern,
but the mechanics of the run are... Well, they're
timeless. History shows this fragility has been
exploited and exposed for centuries, dating way
back to the very origins of organized finance.
The initial examples emerged as part of the broader
cycles of credit expansion and contraction that
defined early capitalism. We can look back to
the 16th and 17th centuries in England. OK. You
had goldsmiths who were essentially functioning
as the first banks. They'd issue promissory notes
for deposited gold. Right, like an IOU. Exactly.
But when bad harvests or wars led to general
famine and unrest, people needed their gold back,
causing severe failures among these early financial
entities. And the same pattern just accelerated
wildly during the great speculative boom. Oh,
absolutely. You see the familiar chaos of the
Dutch tulip manias between 1634 and 1637, where
speculation led to a massive credit expansion
and then a total collapse. And this was mirrored
by two spectacular contemporary failures, right?
It was. The British South... sea bubble from
1717 to 1719, and in France, the Mississippi
Company scheme masterminded by John Law, which
ran from 1717 to 1720. And that one in France,
that led directly to a run. It explicitly led
to a massive cash run on the Banque Royale after
the collapse of Law's speculative empire. These
events really cemented the idea that financial
systems were prone to sudden, violent failure
far beyond the pace of the real economy. But
what's particularly fascinating is that the run
hasn't always been just a reaction to financial
stress. It's been used as a proactive, deliberate
tactic, a form of political blackmail or coercion.
The sources detail an amazing moment in 1832
Britain. The political climate was intensely
volatile. Reformers were absolutely incensed
when the government under the Duke of Wellington
attempted to prevent key political reforms that
would expand the franchise. So how did they weaponize
finance? What did they do? Their rallying cry
was brilliant in its simplicity and effectiveness.
Stop the Duke. Go for gold. Wow. This wasn't
a financial rumor. It was a political command.
Reformers organized mass withdrawals, urging
citizens to take their gold and notes out of
the Bank of England and its private affiliates.
What was the goal? They intended to deplete the
central bank's reserves, paralyzing the government's
ability to function and finance its operations.
And what was the practical effect? Did it work?
The pressure was enormous. Historians estimate
that in just a few weeks, close to $1 .8 million
in gold was withdrawn. This demonstration of
financial force leveraging the inherent fragility
of the gold standard system was enough to convince
the governing elite that continued resistance
to the reform bill was impossible. So it actually
worked. It did. The Duke of Wellington's attempt
to form a government failed, and the reform was
passed. It showed that if trust is the foundation
of finance, coordinated distrust can be a political
battering ram. Moving forward a century. The
era perhaps most associated with the catastrophic
effects of bank runs is the Great Depression
in the United States between 1929 and 1933. The
sheer scale of the banking crises during the
Depression is just hard to overstate. Former
U .S. Federal Reserve Chairman Ben Bernanke argued
compellingly that the economic contraction The
prolonged depth and severity of the depression
was caused directly by these bank runs. Not just
the stock market crash. That was the trigger.
But the bank runs, alongside the Federal Reserve's
failure to provide adequate liquidity and prevent
deflation, that's what made it great. And it
wasn't one single event, right? It was a wave
that moved across the country. Exactly. The geography
of the panics is so telling. They began in the
southern U .S. in November 1930, triggered by
the failure of a major bank chain in Tennessee
and Kentucky, which then just dominoed across
its regional correspondent networks. And then
it hit the cities. Then panic hit major metropolitan
centers. New York City saw runs in December 1930,
though they were contained. Philadelphia, Boston,
Chicago, Toledo, St. Louis, each city experienced
acute multi -institutional runs over the next
three years. It demonstrated a prolonged and
spreading breakdown of financial trust. So what
was the long term macroeconomic consequence of
all this individual panic? Well, economists Milton
Friedman and Anna Schwartz famously detailed
this in their work. They argued that the steady,
widespread hoarding of cash. Meaning people pulling
money out and literally stuffing it under mattresses.
Literally. And that had a compounding effect.
As banks lost reserves, they were forced to liquidate
their loans, calling them in early or selling
them off. Which means less money available for
everyone else. Right. This act drastically and
unintentionally decreased the overall money supply
in the economy, leading directly to the massive
economic shrinkage. The behavioral response of
a nervous public translated directly into severe
monetary policy tightening, completely independent
of what the Fed was doing. This highlights the
critical role of regulation. Our sources emphasize
that bank runs were far more prevalent in U .S.
states whose laws allowed only single branch
banks. This is a crucial comparative point. Single
branch banks are highly dependent on the success
of a hyper localized economy, which often relies
on a single industry like agriculture or manufacturing.
So if the local factory shuts down, the bank
fails. In contrast, look at Canada during the
same era. Canada, with its regulatory structure
that permitted nationwide multi -branch banks,
experienced no bank runs during the Great Depression.
Not one. The diversification of risk across multiple
geographies and industries made their banks far
more resilient to local shocks. It shows that
while fractional reserve banking is fragile,
regulation can be the primary determinant of
risk. And fast forward to the 21st century. The
2008 financial crisis saw analogs to bank runs,
even if they looked different. It was less about
the public queue and more about institutional
fear. We saw what amounted to wholesale runs
on financial institutions. These weren't typically
your retail depositors queuing for cash. Who
was it then? It was institutional lenders and
investors refusing to renew short -term loans
and credit lines to banks they feared were insolvent.
This wholesale market run resulted in the nationalizations
of institutions like Northern Rock in the U .K.
and IndyMac in the U .S. And the trigger then
was what? A combination of extremely low real
interest rates and the proliferation of complex,
unstressed tested financial products like subprime
mortgage backed securities. They collapsed the
moment the housing market began to turn. But
the fundamental principle was identical. A fear
of insufficient liquidity to meet immediate demands.
When a run escalates to a systemic crisis, it's
a failure not just of the banks, but often of
regulatory oversight. Systemic crises tend to
result when regulators ignore or mismanage the
spillover effects of localized risk. And that's
when the government and the central bank have
to step in with massive intervention tools. The
most immediate is emergency liquidity support,
just making sure that viable institutions don't
die from a temporary cash shortage. And guarantees.
Blanket guarantees are also frequently deployed,
promising the public that all deposits, not just
insured ones, are safe. Though the sources note
that these interventions are complex and not
always deployed successfully. When managing a
crisis of this magnitude, the sources highlight
a really dangerous paradox. The delay in intervention.
Delay is the single most costly error. Intervention
is often put off because regulators or politicians
hope that the market will stabilize itself. Or
they're nervous about the political optics of
a bailout. Exactly. But this waiting game dramatically
increases the stress and the eventual cost to
the economy. The longer the delay, the more assets
must be liquidated at fire sale prices and the
deeper the resulting recession. Speed is absolutely
crucial. And when they finally do intervene,
not all cleanup measures are equally effective.
What are the characteristics of successful crisis
management programs? They need to be specific
and transparent. Successful programs are highly
targeted, and they specify clear, quantifiable
rules for assistance. Like what? This includes
rapid corporate restructuring, targeted debt
relief for distressed borrowers to stabilize
asset prices, and crucially, transparently recognizing
all the bank losses and recapitalizing those
banks immediately and sufficiently. I want to
focus on a frequently proposed cleanup strategy
that the sources suggest is actually largely
ineffective. The bad bank concept. Ah, the bad
bank. The idea is elegant in theory. It's a government
-run asset management company created specifically
to buy the non -performing assets. The toxic
loans and junk securities. Right. to take them
off the private bank balance sheets. The private
banks are then left with clean books, which should
allow them to resume lending and investment.
But where does the breakdown occur? If the balance
sheets are clean, why doesn't lending resume?
The core constraint is political, which often
makes these bad banks ineffective, according
to institutions like the IMF. The problem is
asset valuation. How much are they worth? Exactly.
If the bad bank buys the assets at the true depressed
market price, the immediate recognition of massive
losses creates public outcry and anger, forcing
the government to impose severe penalties on
bank management. Okay. Conversely, if the bad
bank buys the assets at an inflated price to
save the bank, which is often the political reality,
it amounts to a massive expensive subsidy for
failed management, putting the public at risk
without restoring market discipline. So it's
caught in a political trap. The political pressure
prevents the bad bank from operating purely based
on cold, necessary economic principles. Let's
shift now from that visible chaos to a kind of
hidden erosion. We need to discuss the specific
and insidious threat that operates below the
radar of a frantic queue. The silent run. The
term silent run has evolved a bit, but one critical
definition released to the slow drain of funds
tied to zombie banks. Zombie banks. These are
financial institutions that are technically insolvent
due to large unbooked loss exposure. They have
huge implicit fiscal deficits, but they continue
operating, often propped up by temporary government
support or just accounting tricks. And as doubt
about them grows, the silent run puts pressure
on everyone, not just the zombie bank itself.
Exactly. Healthy competitors are squeezed because
the zombie bank is destabilizing the entire system.
When funding costs rise, zombie banks often pay
higher interest rates to roll over their liabilities,
which squeezes the profit margins of healthier,
better -run competitors who now have to compete
with those subsidized rates. So the bad actor
drags down the good actors. Yes. And furthermore,
if a zombie bank is forced to sell assets, the
mere knowledge of their distress can drive down
the market value of those assets, imposing capital
losses on healthy banks that hold similar assets.
It's a systemic contagion caused by slow, persistent
decay. Our sources also present a second definition
of the silent RIN, one that's relevant in countries
that do have deposit insurance. This is a subtle
but really telling behavioral pattern. It describes
a phenomenon when insured depositors who know
their funds are safe up to, say, $250 ,000. They
don't empty their accounts completely? No, but
they draw down their balances to just below the
deposit insurance limit. Why do this if their
money is supposedly safe? It's a calculated,
cautious vote of no confidence. It indicates
that they trust the insurance limit, but they
doubt the government's ability or speed to make
good on promises for amounts above that limit.
Or they're afraid they just won't be able to
get their money when they need it. Precisely.
They fear the lack of immediate access might
still cost them opportunities. By moving funds
down to the limit, they signal doubt about the
system's liquidity and operational capacity,
even while acknowledging the financial guarantee.
It's a powerful, quiet signal of rising systemic
distrust. The history of bank runs shows that
stability requires both projecting confidence
from the individual institution and reinforcing
the structure globally. Let's start with the
almost theatrical individual techniques used
historically to avoid triggering a panic. Individual
banks understood that psychology was their biggest
enemy. Historically, they invested heavily in
just projecting stability. The architect. This
is why you see classic banks built with massive
heavy stone facades, marble columns, bronze fittings.
The sheer physical weight and permanence of the
building was intended to communicate that the
bank was heavier and more permanent than the
fleeting fear of the market. And the staff, too.
Similarly, staff were encouraged to dress conservatively
to project an aura of reliability. And before
the existence of federal deposit insurance, the
physical layout of the bank itself was a primary
defense mechanism. It was literally about hiding
the line. Literally. It made sense for a bank
to have an extremely large lobby and highly efficient
service staff. Why? Because the main signal of
a bank run to passersby was the queue spilling
onto the street. So if you keep the line inside.
If the lines were contained inside the enormous
lobby, people walking past were unaware of the
crisis unfolding within. Stopping that visual
signal from reaching the street was a key psychological
tactic to prevent fear from spreading outside
the bank's walls. And if a run started anyway,
banks sometimes resorted to clever, albeit manipulative.
tactics to slow the momentum artificially. Yes.
The goal was always to buy time for the central
bank or other sources of liquidity to arrive.
A common tactic was to enlist employees, friends
and relatives to stand in line and conduct many
small, slow transactions. Really? Oh, yeah. Paying
out small amounts in diverse forms of currency,
anything to artificially slow the flow of genuine
withdrawals. It gives the appearance that the
bank is operating smoothly. but just slowly,
which drains the depositor's momentum and adrenaline.
And then there's the opposite tactic, the visible
show of reassurance. Right. Scheduling prominent,
highly visible deliveries of cash, often in armored
cars, making a point of wheeling large carts
of notes into the vault in full view of the public.
A bit of theater. It's a deliberate show of force
and liquidity designed to convince panicked participants
in the line that the vault is being actively
restocked, thereby removing the scarcity mentality
that fuels the rush. Ultimately, the most powerful
psychological weapon for a bank facing a run
short of actual failure is the threat of suspension
of convertibility. Temporarily suspending withdrawals
stops a run dead in its tracks. But the interesting
finding from our sources is that the threat itself
often proves enough to prevent the run from fully
materializing. How does that work? If a bank
can credibly signal that it's about to stop payments,
it changes the depositor's calculus from I must
withdraw now or lose my cash to if I withdraw
now, I might trigger the suspension and lose
access entirely. That shift in fear can sometimes
pause the panic long enough for regulators to
step in. OK, so let's move to the systemic techniques.
The massive firewalls built into the entire financial
architecture that protect the whole economy.
The most important one in many countries is deposit
insurance. Deposit insurance, like the U .S.
Federal Deposit Insurance Corporation, or FDIC,
is designed to interrupt that self -fulfilling
prophecy. By insuring deposits up to a certain
amount, it removes the individual depositor's
rational incentive to withdraw simply because
others are doing so. For the vast majority of
retail depositors, their money is safe regardless
of the bank's solvency. The reason to run is
gone. But you mentioned earlier that depositors
still fear a lack of immediate access during
a bank failure. How does the FDIC address that
specific fear? The operational strategy is key
here. The FDIC doesn't just guarantee the money.
It guarantees continuity. They keep their takeover
operations secret, conducting the sale or restructuring
over a weekend. So no one knows it's happening.
And then the branches reopen on Monday morning
under new ownership, usually a bridge bank or
another solvent institution. This prevents the
run fears associated with the multi -day lack
of access that historically accompanied bank
failures. The seamless transition reinforces
public trust in the system's resilience. The
second massive systemic defense mechanism is
the central bank's role as the lender of last
resort. This is the ultimate safety valve for
the entire system. The central bank guarantees
that it will provide short term loans to solvent
banks facing unexpected liquidity demands. This
foundational role was analyzed extensively by
Walter Bagehot in his influential 1873 work Lombard
Street. And his classic dictum was that the central
bank should lend freely at a penalty rate on
good collateral. Let's break that down. Why freely,
but at a penalty rate and only on good collateral.
Okay, lend freely is to address the panic, to
assure the market that liquidity is unlimited
and the crisis will not spread due to simple
cash shortages. Got it. On good collateral means
the central bank is not bailing out an insolvent
bank, only a liquid one. This minimizes taxpayer
risk. And the penalty rate. The penalty rate
is crucial because it addresses moral hazard.
It makes it expensive for banks to rely on the
central bank, which incentivizes them to manage
their own liquidity prudently in normal times.
We also have structural regulations designed
to reduce the possibility of insolvency in the
first place, like capital requirements. Rules
like the International Basel III, a court's dramatically
strengthened requirements on how much capital
banks must hold and introduced new regulatory
mandates on liquidity and leverage. If a bank
is forced to hold a greater buffer of high -quality
capital money that can absorb losses, the less
likely they are to become insolvent. Which reduces
the primary fear that triggers a run. Exactly.
If a bank is less likely to fail, the rational
incentive to run is diminished. But this entire
edifice of safety deposit insurance, the lender
of last resort, it creates the classic problem
we hear about in finance, moral hazard. It does.
If we connect this to the bigger picture, The
safety net, while necessary for stability, inherently
reduces the bank's own incentive to avoid risky
behavior. Because they know they'll get bailed
out. If management knows the government will
step in to prevent a systemic collapse, they
may take on excessive risk. Regulators face a
calculated trade -off. Which is? The collective
societal benefits of preventing a catastrophic
systemic collapse are generally believed to outweigh
the costs associated with the increased risk
-taking, provided that regulations like Basel
III mitigate the worst excesses. The final and
rather novel idea for mitigation comes in the
form of a theoretical mechanism involving withdrawal
fees. This concept is modeled as a Pigouvian
device. A Pigouvian device. A fee intended to
correct a negative externality. which in this
case is this self -destructive behavior of the
bank run. Withdrawal fees would be levied by
the bank on successful withdrawals, potentially
increasing in proportion to how fast deposits
are flowing out or how close the bank is to its
reserve limit. So you're literally putting a
price on panic. You're pricing the panic, and
it directly targets the rational calculation
of the running depositor, particularly the uninsured
wholesale depositor, whose money is too large
to be covered by insurance. And the goal. By
imposing a sudden price on the withdrawal, Running
is no longer the most obvious rational strategy.
It forces the depositor to pause, calculate and
consider the cost of joining the run, thus reinforcing
the stability provided by other mechanisms. While
it's not widely implemented in commercial banking,
similar techniques are used to price liquidity
risks in markets like cryptocurrencies and money
market funds. We started with the classic cinematic
cue, but the reality of the 21st century is that
panic moves at the speed of light. not the speed
of a cue snaking around a corner. All different
ballgame. This introduces the new urgent category
of threat, the cyber run. The cyber run is a
critical modern distinction. It's defined as
a rapid massive withdrawal of deposits that is
precipitated not by fears of credit insolvency
that the bank made a bad loan, but by a systemic
operational failure often caused by a cyber attack.
So the fear isn't that the bank has lost money,
but that I, the client, will lose access to my
money when I need it most. Exactly. Depositors
might believe the bank is solvent and holding
healthy assets. But if a crippling cyber attack
disables online banking, card settlement, or
ATM networks, they fear losing timely access
to funds or the ability to settle critical payments.
They run to ensure they maintain control before
the system locks up entirely. And the problem
here is just acceleration. Current regulatory
assumptions were simply not built for this velocity.
This is a major regulatory challenge. We have
the Liquidity Coverage Ratio, or LCR, which requires
banks to hold sufficient high -quality liquid
assets to survive a severe 30 -day stress scenario.
The LCR is based on specific, regulatory -defined
outflow assumptions over that 30 -day period.
What does research show happens when you introduce
a cyber run scenario into that LCR framework?
Well, simulations for systemically important
banks have demonstrated that cyber run outflows
could arrive much faster than the LCR assumptions
allow for. Not 30 days. Instead of 30 days, you
might have hours. If a key payment system node
is compromised, the liquidity shortfalls could
spill over to the entire economy instantaneously,
creating a situation where the banking system
faces operational gridlock. Even if individual
banks theoretically hold enough assets. And this
accelerated speed isn't theoretical. The digital
age has proven it. The collapse of Silicon Valley
Bank in 2023 serves as a really stark illustration
of velocity. It was stunning. While the SVB run
was triggered by solvency concerns related to
bond losses and a failed capital raise, the collapse
was absolutely accelerated by digital speed.
How fast? Customers withdrew $42 billion, nearly
a quarter of the bank's total deposits, within
a single 24 -hour period. $42 billion in a day.
That unprecedented instantaneous velocity was
only achievable through digital banking and wholesale
treasury management platforms. The bank didn't
have 30 days. It had one. And for an example
of an explicit operational shock triggering a
run, we can look to the case of Iran's state
-owned Bank Sipa. Right. In June 2025, Bank Sipa
was hit by a destructive cyber attack that disabled
core banking functions, online services, card
payments, and many ATMs were just down. The operational
failure instantly triggered a physical run. So
the digital failure created the physical queue.
Precisely. Long queues formed immediately outside
the remaining operational branches as deposits
investors rushed for cash. This forced the bank
to impose ad hoc withdrawal limits and temporary
closures. And the panic spread. It spread so
rapidly that the central bank had to intervene
days later, declaring a 50 percent increase in
liquidity supplied to the entire banking system.
Behavior analysts confirmed it was a classic
bank run, but the trigger was purely operational
failure, not credit risk. So if the technology
is moving faster than the regulations, what are
the proposed safeguards against these ultra -fast
cyber runs? Regulators are recognizing they need
operational firewalls. One key proposal is the
creation of an emergency payment node. What's
that? Think of it as a dormant, narrow, pre -authorized
payment bank activated only during a systemic
operational outage. Its sole purpose would be
to process critical wholesale payments between
vital financial firms, maintaining payment continuity
when the main platforms are down. And regulatory
oversight itself needs to evolve to match the
threat. Absolutely. Regulatory stress tests must
now incorporate cyber -run scenarios with the
same rigor traditionally applied to credit risk.
We need to be testing for operational fragility
and velocity. You have to ask. You have to ask.
Can the system process high -volume rapid withdrawals
during systemic failure? Or will the platform
itself become the point of failure? This requires
anticipating how rapidly fear can be communicated
and actioned in a world of instant digital transfer.
So we've covered a massive amount of ground today,
tracking the bank run from the 17th century goldsmiths
to the instantaneous digital chaos of today.
And the core takeaway for me remains absolutely
constant. The vulnerability of banks stems from
their essential beneficial role as liquidity
providers. That's it. They take illiquid long
-term risk like loans and transform it into liquid
short -term security, our deposits. That asset
liability mismatch is both the architectural
necessity and the architectural flaw. And we
saw how that vulnerability scales from the individual
run to the panic, culminating in a systemic crisis
that can cost a nation a fifth of its GDP in
lost output. Yeah. The psychological loop, that
self -fulfilling prophecy, is what transforms
rational individual action into collective economic
destruction, driven by the game theory of who
gets out first. And this financial reality, this
deep fear of scarcity and loss of access, is
so deeply imprinted on our collective storytelling.
The bank run isn't just a dry economic concept.
Not at all. It's a dramatic pivot point in fiction.
From the crisis at the building and loan insecurity,
it's a wonderful life. To the run on the bank
in Mary Poppins or the classic 1932 film American
Madness. These cultural references show how real
economic trauma just leaves a lasting mark on
our narratives. So what does this all mean for
you listening to this? We learned that a bank
run is essentially a rational panic based on
distrust in the institution or the system. Right.
Given that the modern. safety nest deposit insurance
central bank liquidity are designed to eliminate
the financial incentive to panic this raises
an important and i think provocative question
which is when digital velocity allows billions
of dollars to move in a single day is the ultimate
defense against a modern bank run less about
physical reserves and more about instantaneous
unwavering public trust transparency and effective
communication especially when operational failures
can trigger a panic just as easily as insolvency
fears the speed of information and the speed
of digital finance means that maintaining stability
in the 21st century requires not just deep balance
sheets but but absolute instantaneous confidence
in the integrity of the system itself. Something
for you to mull over the next time you tap your
phone to check your balance.