UNDERSTANDING BANK RUNS
September 19, 2008
The image of long lines of agitated customers clamoring to withdraw their deposits from failing banks traditionally has been associated with the Great Depression -- that is, until the recent bank runs in the United States, Britain and India. In their study, the National Bureau of Economic Research (NBER) determined factors that propel bank runs and policies that may help mitigate the predilection for a bank run.
Researchers analyzed a unique database of minute-by-minute withdrawal activity at a besieged bank in India following revelations in 2001 of a massive loan fraud perpetrated by the largest cooperative bank in the region. Among the most significant findings, researchers determined that the phenomenon they called the "contagion effects of bank run behavior" is something akin to the spread of disease, and that community networks are important. In other words: If people in your network run, you are more likely to run.
Equally significant are the factors that can mitigate the propensity to make a run on the bank, say the researchers. For example:
- Deposit insurance helps, but only partially.
- The longer customers have had their money in a bank, the less likely they are to join the stampede to withdraw their funds.
- Similarly, if the customers have taken loans from the bank in the past, they are less likely to run in response to rumors about the bank's solvency.
- The length and depth of a customer's relationships with the bank act as a dampening factor on the depositor's inclination to run.
These results suggest that one rationale to encourage cross-selling of deposits and loans is not simply to enhance revenues, but to help protect the bank by acting as a complementary insurance mechanism.
Furthermore, researchers conclude that most depositors who run do not return to the bank, suggesting that the effects of bank runs are indeed long lasting.
Source: Rajkamal Iyer and Manju Puri, "Understanding Bank Runs: The Importance of Depositor-Bank Relationships and Networks, National Bureau of Economic Research, Working Paper, No. 14280, August 2008.
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