What is a bank run and how can it lead to a banking crisis?
This article explains the reasons and consequences of bank runs in general.
The recent failure of the Silicon Valley Bank and its shutdown by the United States financial regulators has raised concerns and people are asking: what is a bank run? We are not getting into the specifics of what happened with Silicon Valley Bank, but rather we will take a broader look on what is a bank run, what triggers it and how it can lead to a banking crisis. We will also explain some key differences between a bank account and a Voima Account.
Bank run and its consequences
The bank account balance is the bank’s debt to the depositor
When a client deposits money into a bank account, they are loaning their money to the bank. The bank account balance represents the bank's debt to the depositor, and the bank is responsible for repaying the deposited amount on demand or as agreed upon in the account agreement.
The bank uses the deposited money to invest or lend it forward to generate revenue. This means that the deposited money might not be immediately available in cash for the depositor to withdraw. The bank uses the money to fund its business operations and invest in various financial products, which may not be immediately liquid—or, in other words, convertible to cash. If the bank's investments or loans turn sour, it may have difficulties in repaying the depositors.
A bank run occurs when depositors start withdrawing their money from their accounts in large quantities
A bank run occurs when a large number of depositors suddenly withdraw their money from a bank due to fears that the bank may become insolvent and be unable to return their funds. This can happen because of rumours, news reports or other factors that lead depositors to lose confidence in the bank's ability to repay its obligations.
A bank run leads to an information cascade, where people not initially worried about their deposited funds start withdrawing them too after rumours and fear for the safety of the deposits spread. As such, a bank run turns into a vicious cycle and a self-fulfilling prophecy.
The consequences of a bank run can be severe. If a large number of depositors try to withdraw their funds at the same time, the bank may not have enough cash on hand to meet these demands. This is called a liquidity crisis. This may force the bank to sell its assets at a loss, which can lead to the bank's failure. Silicon Valley Bank had to sell government bonds at a loss before their maturity and failed to cover the losses with new funding. Governments may have to step in to guarantee deposits, as has happened in the case of Silicon Valley Bank.
Effects may not be limited to personal finances but the economy at large
Not only may a person lose their personal wealth, but the failure of a bank can have ripple effects throughout the financial system and the whole economy. Other banks may become hesitant to lend to each other, leading to a credit crunch and a contraction of the money supply. Companies may lose access to their deposited funds and, as such, be unable to pay for their wages, operating expenses and debts, leading to a cascading failure. As many of Silicon Valley Bank’s clients were Silicon Valley startups, there was a danger for those companies to be unable to cover their operating costs had they lost access to their deposits in the bank.
In the worst-case scenario, a bank run can trigger a systemic banking crisis that can have long-lasting effects on the economy. A bank run may cause the confidence in the banking system to be lost overall, triggering bank runs in other banks too.
Deposit guarantees are the governments’ way of protecting the deposits in a failing bank
In case of a bank’s failure to pay the withdrawals, governments have set up deposit guarantees, sometimes called deposit insurances or deposit protection. This is not only to protect the wealth lent to the bank but also to try and prevent bank runs from happening. By guaranteeing deposits up to some amount, bank clients are dissuaded from contributing to bank run problems by assuring them their deposits are safe even in a case of a bankruptcy.
In Finland, the deposit is insured up to a maximum of €100,000 of a depositor’s deposits in a single bank.
Voima is always able to pay the Customers’ withdrawals
Contrary to a bank account balance, the Voima Account balance is not Voima’s debt to the Customer
You own the gold on your Voima Account. This is crucially different from how modern banking is done: If you open an account at a bank, you agree to lend your money to them. It is the bank's property and is thus listed on their balance sheet, allowing them to reinvest your deposit.
The gold held on a Voima Account is not lent to Voima, but rather the Customers are the true owners of the gold. Voima is simply the custodian of the Customers’ gold and so the Customers’ gold does not appear on Voima’s balance sheet. Voima Account helps Customers to protect their assets by allowing them to hold gold instead of deteriorating currencies.
Since the gold is not lent to Voima, there can be no bank run. You can read more about how Voima Account differs from a bank account here.
Consider securing your wealth with Voima today
To start securing your wealth with audited and insured gold on a Voima Account, you can either contact us or open your account online yourself. Voima Account allows you to conveniently own gold that is stored safely. You can also have gold delivered to you by purchasing bullion and coins from Voima Store.
Open your Voima Account today!