Bank Runs: When Banks Get Caught in a Spiral of Fear

The collapse of Silicon Valley Bank (SVB) and the wider crisis that ensued has once again made clear that banking is a confidence game. Once that confidence is rattled and customers lose faith in a bank or the entire banking system, it’s very hard to avert a downward spiral that can ultimately lead to disaster, i.e. bank failure(s).

Often enough, rumors of trouble at a bank are enough to trigger a bank run, as affected banks enter a negative feedback loop of (alleged) problems causing panic, causing mass withdrawals, causing more panic, more withdrawals and so on and so forth. Once banks get caught in this downward spiral, it is only a matter of time before they run into actual liquidity problems, forcing them to sell off assets, often at a loss as was the case at SVB. Those losses further worsen the position of the bank, causing more panic, more withdrawals, you know the drill.

Knowing that a spark of panic can set the entire banking system on fire, it’s understandable why the Fed, the FDIC and the federal government stepped in so decisively, making customers of SVB and Signature Bank whole and promising additional liquidity to other banks struggling to keep up with withdrawal requests. They were trying to restore confidence in the banking system, to contain the fire before it spreads and to avert a full-blown banking crisis.