Bundesarchiv, Bild 102-12023 / Georg Pahl / CC-BY-SA 3.0, CC BY-SA 3.0 DE via Wikimedia Commons
Set against the backdrop of the Great Depression, the 1946 classic, It’s a Wonderful Life, centers around themes of love, family, and redemption, but its most memorable scene happens during one of its darkest moments.
Banker George Bailey, portrayed by Jimmy Stewart, had put aside his own dreams to stay in his hometown of Bedford Falls and run the family business, Bailey Brothers Building and Loan, when shortly after his marriage to Mary Bailey (played by Donna Reed), the unthinkable happens.
The stock market crashes, and panicked customers flood into the bank demanding their money back.
What Is a Bank Run?
While the scenario described above comes from a work of fiction, it is very much based on reality. Bank runs can and do happen when many customers, concerned about a bank’s solvency and the safety of their deposits, try to withdraw their balances at once. This drains the bank's reserves, and as more customers try to make withdrawals, the bank runs out of cash to fulfill them.
This occurs because banks don’t actually keep their customers’ money sitting around on-hand gathering dust—they use most of it to make more money by providing loans and investing in securities, while keeping only a small percentage of it on-hand to service withdrawals.
In his lovable, stammering way, Stewart’s character in It’s a Wonderful Life tries to calm his angry customers down by explaining where their money went, saying:
“You're thinking of this place all wrong,” Bailey says, “As if I had the money back in a safe. The money's not here. Your money's in Joe's house...right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why, you're lending them the money to build, and then, they're going to pay it back to you as best they can. Now what are you going to do? Foreclose on them? … Now wait … now listen … now listen to me. I beg of you not to …”
—It’s a Wonderful Life
Sadly, his customers aren’t convinced, and George and Mary must use their honeymoon savings to keep the bank solvent.
What Happens During a Bank Run? What Causes It?
While Hollywood ensures the Bailey family has a happy ending, bank runs are very real, and their outcomes are often quite tragic. Any cause of panic, such as a supply shock, a war, or a stock market crash, can spark fear and mistrust in customers of a bank or other financial institution because, whatever the reason, they believe it is going to fail.
The customers all withdraw their money from the bank at the same time, which forces the bank to liquidate its assets. As the bank loses its money, it also cannot pay interest on its loans and other investments, and a “self-fulfilling prophecy” occurs, because it really does go out of business.
What Are Some Real-Life Examples of Bank Runs?
A series of bank runs occurred during the Great Depression—in fact, many say this prolonged the financial crisis into a decade-long ordeal. During the Roaring 20s, banks made it easy for investors to speculate by introducing the concept of margin, which meant investors could buy stocks on borrowed money, sometimes for as little as 10% of their share value, which would come back to haunt them when the market crashed.
In addition, banks kept few reserves on hand (some kept none at all), and nearly all were limited in their abilities to access their reserves during times of emergency because, up until that point, there had been little regulation over the banking industry.
Sometimes, all it took was mere rumor for a bank to fail. Here are a few of the most famous bank runs:
- In 1930, a bank run began at the Tennessee Hermitage National Bank of Nashville, Tennessee. Hundreds of customers waited in a line that stretched around the block with the promise they would be paid in full, although the bank would actually run out of funds by just 2:00 p.m. This sparked a wave of bank runs across the south, and 120 southern banks would go on to fail during the Great Depression.
- The New York Times reported that a business owner visited the Bank of the United States in the Bronx in December 1930 and requested to sell all of the common shares he owned. The bankers persuaded him not to sell with reassurances that their institution was sound; later that day, he spread rumors that the bank refused the sale of his stock. By the end of the day, more than 2,500 customers had withdrawn over $2 million. Over 740 banks across the country would fail in the 10 months following the 1929 market crash.
How Were the Bank Runs of the Great Depression Resolved?
In an attempt to restore faith in banking institutions, and thus prevent further bank runs, in March of 1933, President Franklin Delano Roosevelt declared a four-day “Banking Holiday.” He closed banks for federal inspection to ensure they could remain solvent. He also removed the United States from the gold standard and outlawed individual ownership of gold. Incredibly, when banks reopened on Monday, March 13, 1933, throngs of customers reappeared at their banks’ front doors, willing to do business once again.
Congress also passed banking reforms, such as the 1933 Banking Act, more commonly known as the Glass-Steagall Act, which created the Federal Deposit Insurance Corporation (FDIC) and established rules to prohibit banks from acting like investment entities. The FDIC also protects individual depositors—in fact, since 1934, the FDIC says there hasn’t been a single cent of FDIC-insured deposits lost due to bank failures.
Can Bank Runs Be Prevented?
Today, most countries employ a fractional reserve banking system, where a bank only keeps a small percentage of its total deposits on hand, lending the rest to other banks or investing in other assets in order to earn interest. After all, a bank’s main business is to make money.
However, a central bank, like the Federal Reserve, manages the amount of interest it lends out to banks called through its discount window. It also sets a rate of interest that banks can charge to other banks, which is known as the Fed Funds Rate.
The Fed raises, maintains, or lowers its interest rates according to prevailing economic conditions. When an economy is in a recession, for example, it may decrease interest rates to make it easier for banks to lend to businesses and consumers, and thus spur growth.
Banks use a fractional reserve system because it allows them to keep only a small percentage of cash on hand in the form of vault cash or as deposits with their nearest Federal Reserve bank. Since the Great Depression, the Federal Reserve has added measures to protect consumers by mandating that banks hold a minimum of 10% of their checking deposits as reserves.
Individuals are also protected by the FDIC, which ensures that bank account balances of up to $250,000 are backed by the “full faith and credit of the U.S. government.”
Banks also do their part to try to prevent customers from withdrawing en masse by imposing limits on how much cash a customer may withdraw per day. In the event of an emergency, they could also suspend customer withdrawals altogether or request assistance from another bank—or even the Federal Reserve itself.
The Fed was once known for laissez-faire management of the country’s banking system, but after the hard lessons the Great Depression delivered, it has increasingly positioned its actions in the best interest of all Americans, which goes a long way in restoring confidence.
For example, after the stock market crash of 1987, newly appointed Fed Chairman Alan Greenspan calmed the markets by releasing a statement of support the very next morning. The Fed also immediately slashed interest rates and promised to serve as a source of liquidity. Many believe Greenspan’s quick thinking prevented bank runs from occurring—and the Dow Jones Industrial Average actually recouped its losses just 2 trading sessions later.
And if all else fails, a banker could always get atop a soapbox and deliver an impassioned speech—just like George Bailey.
