On March 10, 2023, the 16th largest bank in the United States failed due to a run on its bank. To be fair, many factors led to the collapse of Silicon Valley Bank, but the run on the bank was the final factor that led to the bank’s demise. As an aid in understanding bank runs, we will briefly describe the basics of banking and some factors that can lead to a bank run.

BANK RUNS

A bank run, also known as a run on a bank, “ is when a large number of customers of a bank or other financial institution withdraw their deposits at the same time over fears about the bank’s solvency.” This definition by investopdea.com describes an essential part of bank runs, which is “a large number of customers” taking out their money at the same time. This is a problem because banks do not hold all of their customers’ deposits in the bank. When a large number of customers make a run on a bank, it is because they, for one reason or another, lost confidence in the bank. Which leads to the second part of the definition, “fears of the bank’s solvency.” Solvency is the ability to cover debt with the availability of assets. A bank run occurs when customers have a fear that a bank may not be able to pay all its bills. In the case of Silicon Valley Bank, the fear of the bank’s solvency arose when the bank’s investment lost money. The bank was forced to raise new money in a short amount of time, which triggered a chain reaction from the bank depositors. SVB customers are mainly tech startups, which means they are holding a larger amount of deposits than your average person. Many customers of SVB, due to fear, were withdrawing millions of dollars, which led to billions in a short amount of time. 

BASICS OF BANKING

To better understand bank runs, it is important to be familiar with the basics of how banking works. A bank, at its essence, is a business, and similar to other businesses, its goal is to make profits. Banks make profits by collecting deposits from customers and then investing the deposits in investment opportunities. This is a very simplified explanation of how a bank works, but it will help you understand the concept of bank runs. 

While many of us are more familiar with the collecting deposits aspect of banking–because many of us have bank accounts–we may only be familiar with a limited aspect of how banks invest their money. Some well-known investments of banks that we are familiar with are mortgage loans, car loans, and personal loans. Banks provide loans to customers at a higher interest rate than what they are paying on deposits. The difference between what they are paying out on the interest of deposits and what they are receiving on the interest on loans are profits.

Providing loans to customers can be very competitive due to the fact that other banks and financial institutions are doing the same; it is not unusual for banks to look elsewhere to make profits. It is not unusual for a bank to invest in a variety of industries and sectors in the United States and around the world. They invest in stocks, bonds, mutual funds, and more. If there is an opportunity to make money, the chances of a bank being involved are high.   

One of the fundamental rules of investing is the higher the risk, the higher the return. If a bank finds itself taking on too much risk, it can leave them exposed to great losses. Banks, whether private or public, are responsible for sharing information about their operations with their shareholders, stakeholders, and customers. A bank investment doing poorly doesn’t necessarily lead to a bank run. In 2012, JP Morgan Chase, one of the largest banks in America, lost $2 billion in an investment. As alarming as this was, it didn’t put customers in a frenzy, causing them to pull their money from the bank. JP Morgan Chase customers, shareholders, and stakeholders had enough confidence in the bank to remain with the bank. 

Wells Fargo, over the years, has received many fines due to their conduct. In 2020 they settled a lawsuit with the SEC for $3 billion because employees were opening fake accounts to meet sales quotas. In 2022, the Consumer Financial Protection Bureau ordered Wells Fargo to pay $3.7 billion for illegally charging customers fees, fines, and extra interest rates. Despite these fines and other poor conduct by the bank, it did not shake customers’ confidence enough to lead to a bank run. This proves that depositors understand the volatility of businesses and doesn’t mean they will run to pull their money from banks with every sign of trouble.

RESULTS OF BANK RUNS

Bank runs can lead to many outcomes, with the worst being a collapse in the financial system or a recession and a depression. The best-case scenario is a bank being able to meet the high influx of customers’ demand. Banks are required to hold 10% of deposits. This can be a problem if more than 10% of deposits are withdrawn by customers at the same time. The Federal Deposit Insurance Corporation (FDIC) was created to prevent bank runs by insuring deposits up to $250,000. Which was created during the Great Depression to restore confidence in the banking system. This measure has done well to decrease the number of bank runs since its inception in 1933. Silicon Valley Bank’s unique position of having customers with deposits far more than the $250,000 FDIC insured amount put them in a precarious situation. 

FINAL THOUGHT

As we can see, bank runs are a unique phenomenon that can be the result of many factors. Ultimately the main factor is people losing confidence in the financial systems caused by fear. Government agencies have done a lot to prevent bank runs over the years, and it is impossible for them to foresee all factors that could lead to a bank run. The SVB situation was quite unique because the measures that were in place (FDIC insurance) to prevent a run on the bank were not relevant to SVB’s unique situation. SVB’s customer base had deposits far above the FDIC-insured amount, which led to their panic. The FDIC was swift to step in by guaranteeing all amounts of deposits, which is more than the $250,000 they already have in place. This was effective in preventing a domino effect that could lead to a massive financial crisis. With that said, it set a concerning precedent that could lead to risky behavior by a banking industry that already has a history of risky behavior.