What makes a run on bank When is the government intervention necessary Essay

What makes a run on bank When is the government intervention necessary - Essay Example A bank run progress is an automated momentum gaining process which is, said or believed comes true as the peoples are expecting it to come true: eventually as the deposition withdrawals increase the image of the bank falls provoking many withdrawals. Continuation of a bank run for long time can result in a bankruptcy as bank runs have a very ugly reputation. Insecurity during a bank run creates fear to same extent when the room is on fire. The panic drives us to the nearest visible exit blindly like a reflex without a single thought that the seen exit shown up like an oasis is really an exit or just a mirage. Sometimes it is better not to take risks with your money. The panic or â€Å"the shout† of a bank run is as fast and as growing like a fire. This panic takes an epidemic look as the depositors start to feel the same with other banks too as an incoming shock as this kind of economic disasters are very frequently on the headlines. It’s like when my friend’s ba nk is under a bank run the next bank could be mine. So a bank run is efficiently capable of contaminating its misfortune to cause several bankruptcies at least if the total economic breakdown is managed to block. (Shin, 2009) What causes bank run? Banks have an origin of centuries. Once they were just little shops that were used to collect fund from people and use them as to lend to the borrowers. This model, however, does not look much tough. Particularly in case of depositors, they can freely withdraw their money with a small penalty where a bank cannot ever ask for the money to be returned whenever they need it. Thus, an error arises in this model. In order to nullify this error a bank generally keeps a cash reserve which the bank uses to lend money to the borrowers taking only a little part from the deposits. However, if the bank is completely healthy it can survive a bankruptcy in the long run, but the sufferings of a bank run cannot be avoided when many people take their money back much than the cash reserved. So if a rough situation arises like this all depositors may not get their money back. The thing that makes the situation much worse is the first come first serve policy of the withdrawal. As long the bank have their cash reserve depositors can take their money back, but beyond the cash reserve level the bank is unable to return the money back. Hence, the insecure and desperate depositors rush to the bank to take their money bank thinking this to be a bank run. On forcing the borrowers to return fast the bank undergoes a loss as fire sales occur and the money taken back is very less may be less than the total deposits. In September 2007, a United Kingdom bank called Northern Rock experienced a severe bank run when depositors rushed to the bank to withdraw their money. UK experienced bank run even before. In case of US also bank run was not uncommon prior to 1930s. However, bank runs become rare after that. Why do bank runs exits?   There are three main reasons. (Shin, 2009) (I) Individual Liquidity Shock: Money could be needed in any time as an individual could suffer a liquidity shock for various reasons such as damage repairs from any sort of disaster, loss of earning, emergency hospitalization which leaves no choice to the depositors to withdraw their money. When the individual liquidity shock is completely independent and there are multiple depositors ten we consider it as the aggregate liquidity shock is non- stochastic, so in that case for a particular period of time a fixed amount of deposits are allowed to be withdrawn. This way the policy of cash reserve can resolve the bank run problem. In reality completely independent liquidity shocks are quite unrealistic as aggregate liquidity shocks are found normally in the time of currency crisis or natural disasters. That