Econ310_Notes20101130

Econ310_Notes20101130 - P re- FDIC Bank Runs & Panics...

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Econ 310-004 Definitions bank run – many customers simultaneously try to cash out deposits (or banknotes), out of concern that the bank will default if they wait bank panic – many banks experience runs in the same period Principles A run on an insolvent bank can force the bank to close before it squanders more on risky investments. The threat of a bank run incentivizes depositors to monitor how risky bank investments are. When nobody runs on insolvent banks, they often become zombie banks that take ever greater gambling risks to get back to even. Depositors can run on a solvent bank that subsequently becomes insolvent due to the run (fire sale losses on assets liquidated to pay withdraws). Bank panics were far more frequent in highly regulated countries (e.g., U.K. and United States). When country banks needed reserves (due to bond collateral restrictions on banknote issue), they would withdraw from city banks, which would then withdraw from big banks in NYC or Chicago. A bad crop could cause locals to believe all banks in the area had bad loans and were insolvent. This would trigger bank runs, and withdrawals up the chain. Fire sale losses to pay out bank depositors could then make the city and big city banks insolvent. Reasons bank runs are harmful
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Econ310_Notes20101130 - P re- FDIC Bank Runs & Panics...

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