Bank Runs and Liquidity Management Tools

Matthias Bergner, Patrick Marcus and Maria Adler

Bank runs are prominent events which usually occur in a fractional reserve banking system during extreme financial crises and represent important events in monetary history. During such a bank run a huge number of depositors begin to rush to withdraw their deposits because there is an implied expectation from the market that the bank will fail. During the further progress of a bank run, it starts to generate its own momentum, which ends with a self-fulfilling prophecy because more clients begin to withdraw their deposits. This drives the bank’s need to liquidate many of its illiquid assets at a discount (“fire sale”). Eventually, these losses are likely to result in the bankruptcy of the institution.

Even more critical is a banking panic with many bank failures. People suddenly try to convert a wide range of deposits at risk into cash and leave the domestic banking system at the same time. This causes a disruption of the monetary system and from there on a reduction in the production level. The result of such an event with many bankruptcies usually causes a long economic recession. For instance, the Great Depression’s economic damage in the 1930s was a direct result of the many