Silicon Valley Bank is only the latest bank to suffer from a bank run.
Why It Matters: The Silicon Valley Bank Run started on March 11, 2020, when a group of customers began withdrawing large sums of money from their accounts. The withdrawals reportedly amounted to hundreds of millions of dollars, and were triggered by concerns about the bank's exposure to risky loans and its ability to weather the economic impact of the COVID-19 pandemic.
While the SVB bank run was short-lived and ultimately did not cause a systemic crisis, it highlighted some important issues about the role of digital banking, the risks of liquidity, and the challenges of managing growth in a fast-changing industry.
In order to understand what happened, let’s look at what a bank run is and how it affects bank customers.
Defining a bank run
A bank run is a situation where a large number of customers of a bank withdraw their deposits simultaneously due to concerns about the bank's solvency. This can lead to a domino effect where more and more customers rush to withdraw their deposits, ultimately leading to the bank’s failure.
In regards to SVB, the sudden surge of withdrawals led to rumors and speculations about the solvency of the bank, which quickly spread on social media and news outlets. Some customers reported difficulties in accessing their accounts or getting satisfactory explanations from the bank’s customer service.
The situation escalated after news leaked that the Federal Reserve and the FDIC contacted SVB to inquire about the bank's liquidity and risk management practices.
Causes of a bank run
There are several factors that can trigger a bank run. One of the most common causes is a loss of confidence in the bank’s ability to meet its financial obligations creating a risk of insolvency. This can be spurred leaks, rumors, news reports, or other negative publicity that raises concerns about the bank's financial health.
Another factor that can lead to a bank run is a sudden increase in demand for withdrawals such as in the face of economic downturns or crisis. For example, if a large number of customers need cash to cover debts or emergency expenses, they may rush to the bank to withdraw their funds all at once.
Finally, a bank run can be triggered by a general lack of confidence in the banking system as a whole. This fear can be contagious and lead to a panic, causing even more people to withdraw their funds, creating a self-fulfilling prophecy of the bank's failure. This is known as financial contagion and can spread quickly, impacting otherwise solvent institutions.
The risk of bank runs is further compounded when depositors are aware that their funds are not insured or guaranteed by a government entity, making them more likely to pull their deposits when suspicions emerge about the health of a specific bank or the banking sector writ large.
To prevent bank runs from occurring, many countries have established deposit insurance programs, such as the Federal Deposit Insurance Corporation in the U.S., that guarantee a certain amount of deposits in the event of a bank failure. Additionally, central banks can provide emergency liquidity to banks that are experiencing a sudden surge in withdrawals.
Consequences of a bank run
The consequences of a bank run can be severe, both for the bank and its customers. When a large number of customers withdraw their deposits all at once, the bank may not have enough cash on hand to meet their demands. This can lead to a liquidity crisis and force the bank to sell off assets—usually at a loss—or borrow money to cover the shortfall.
If the bank is unable to meet its financial obligations, it may be forced to declare bankruptcy or be taken over by regulators. This can result in the loss of customer deposits, as well as job losses for bank employees.
Even if the bank is ultimately bailed out or acquired by another institution, it can take weeks or even months for depositors to access their funds and there is no guarantee that they will recoup their deposits beyond FDIC insurance limits.