What is a bank run?
A bank run occurs when a large number of customers of a bank or financial institution withdraw their deposits en masse, due to concerns about the bank's solvency. As more people withdraw money, the probability of default increases, causing more people to withdraw their deposits as well. In extreme cases, bank reserves may not be enough to cover withdrawals and eventually lead to default.
Understand bank run
Bank runs are often the result of panic, rather than actual insolvency. It starts with panic, but can eventually turn into a real default situation. That's because most banks don't keep much cash at their branches. In reality, institutions have a certain limit on how much money they can store in their vaults each day. These limits are set based on need and for security reasons. The Federal Reserve Bank also sets internal cash limits for institutions. The money they have on their books is used to lend to others or invest in various investment vehicles.
Because banks typically keep only a small percentage of deposits on-site, they must increase their cash holdings to meet customer withdrawal demands. One method banks use to increase cash on hand is to sell off its assets, sometimes at significantly lower prices. Losses from selling assets at lower prices can cause banks to become insolvent. Panic occurs when many banks run at the same time.
Bank runs in traditional financial history
In modern history, bank runs are often associated with the Great Depression. Amid the stock market crash of 1929, American depositors began to panic and sought refuge by holding cash. The first bank failure due to a mass run occurred in 1930 in Tennessee.
This seemingly small and isolated incident prompted a series of subsequent bank runs across the South and then throughout the country, as people heard what had happened and sought to withdraw their money before they lost it. saving money.
The succession of bank runs that occurred in the early 1930s represented a kind of domino effect, as news of a bank failure caused customers of neighboring banks to panic and withdraw their money.
In response to bank runs in the 1930s, the United States government established several regulatory mechanisms to prevent this from happening again, including the creation of the Federal Deposit Insurance Corporation (FDIC). , today insures depositors for up to $250,000 per banking institution.
The 2008-2009 financial crisis continued to occur with a number of notable bank runs. On September 25, 2008, Washington Mutual (WaMu), America's sixth largest financial institution at the time, was closed by the United States Office of Thrift Supervision. In the following days, depositors withdrew more than $16.7 billion in deposits, leaving banks depleted of short-term cash reserves.
The very next day, Wachovia Bank closed for the same reason, when depositors withdrew more than $15 billion in a two-week period after Wachovia reported negative earnings at the beginning of that quarter. The majority of withdrawals at Wachovia are concentrated in commercial accounts with balances above the $100,000 limit insured by the Federal Deposit Insurance Corporation (FDIC), withdraw those balances immediately below FDIC limits.
However, the failure of major investment banks such as Lehman Brothers, AIG and Bear Stearns was not due to a bank run. Instead, it was due to a credit and liquidity crisis involving derivatives and collateral.
Solution to prevent bank run
In response to the turmoil of the 1930s, governments took a number of steps to reduce the risks of future banking activities. Perhaps the biggest was establishing reserve requirements that required banks to maintain a certain percentage of total deposits in cash.
Additionally, the United States Congress established the FDIC in 1933. It was created in response to the many banking failures that had occurred in previous years. Its mission is to maintain stability and public confidence in the United States financial system. In some cases, banks have taken a more proactive approach when facing the risk of bank runs:
Cooling down: Banks may choose to close for a period of time if they face the risk of a bank run. This prevents people from waiting for withdrawals.
Borrowing: Banks can borrow from other institutions if they do not have enough cash reserves. Large loans can prevent them from going bankrupt.
Insured deposits: When people know their deposits are guaranteed by the government, fear is often alleviated. This has been happening since the United States established the FDIC.
Central banks often act as a last resort to lend to individual banks during crises such as bank runs.
Looking back at the case of FTX, the collapse of the exchange caused a cryptocurrency bank run. Panicked users withdrew more than $8 billion from exchanges, including $3.7 billion in Bitcoin, $2.5 billion in Ether, and more than $2 billion in stablecoins. The pain then spread to other cryptocurrencies, with the total value of the market falling 12% immediately after news of the FTX incident.
The exchange led by Sam Bankman-Fried has been experiencing “significant” liquidity problems, leading it to seek a bailout from rival Binance. The rescue ultimately failed when Binance CEO Changpeng Zhao said the due diligence process revealed problems that could not be resolved. That caused FTX to declare bankruptcy, halting customer withdrawals.
The consequences that FTX causes drag many companies into a similar situation. Cryptocurrency lender BlockFi, which was bailed out by FTX and Sam Bankman-Fried last summer, is preparing to file for bankruptcy, after having to halt its deposit and withdrawal services. Recently on November 16, Genesis Global, a cryptocurrency lending institution, also announced it would temporarily suspend redemption transactions and new loans. Genesis Global claims unusual market instability related to the collapse of ailing cryptocurrency exchange FTX was the reason for the decision…
The exchange's collapse has led experts to compare it to the collapse of Lehman Brothers in 2008, while others, like former Treasury Secretary Larry Summers, have compared it to the collapse of Enron. .
The fall of FTX was followed by an increase in stablecoin inflows and DEX activity. Delphi Digital used asset baskets to analyze the performance between DEX and CEX tokens and found that when compared to BTC, the DEX basket increased by 24%, while the CEX basket decreased by 2%.
On-chain activity correlates with overall Bitcoin, Ether and altcoin market sentiment, with the current FTX turmoil having catalyzed exchange outflows. One trend likely to emerge from the current chaos is the steady rise of self-custodial cryptocurrencies and the increased use of DEXs.
