What is a Banking Panic and Why Does it Happen

A banking panic is a rare but intense event where many people rush to withdraw their money from banks at the same time, fearing a bank's collapse. This can lead to a run on the bank, where the bank's assets are insufficient to cover the withdrawals.

This usually happens when there's a loss of confidence in the banking system, often due to a perceived risk of bank failure.

A bank's assets and liabilities are closely monitored, but sometimes the bank's assets may not be enough to cover all its liabilities, making it seem like a bad investment.

A banking panic occurs when a large number of people rush to withdraw their money from banks, often due to a lack of trust in the financial system. This can happen suddenly and without warning.

One of the main causes of banking panics is a loss of confidence in the banking system, which can be triggered by a bank failure or a series of bank failures. This can lead to a run on the banks, where depositors withdraw their money in large quantities.

For another approach, see: In a Fractional Reserve Banking System Banks Create Money Because

A bank failure can occur when a bank runs out of liquidity or becomes insolvent, meaning it doesn't have enough assets to cover its debts. This can happen due to a variety of factors, including a decline in the value of assets held by the bank.

The size and complexity of the banking system can also contribute to banking panics. As the system grows, it becomes more difficult to track and manage risk, making it more likely that a bank will fail.

Economic downturns can also lead to banking panics, as people become more cautious with their money and withdraw their deposits from banks. This can create a self-reinforcing cycle of fear and panic.

Banking panics are complex events, but understanding their characteristics can help us grasp what's happening. Banking panics can be local, regional, or national in scope, but their effects can extend far beyond the initial location.

A sudden and unanticipated revision of expectations of deposit loss is often the origin of a banking panic. This can lead to a class of financial shocks, including panics in the stock market and foreign exchange market.

Banking panics can be accompanied by money market stringency, a stock market collapse, loan and deposit contractions, and runs on banks. This can lead to bank failures, the issue of Clearing House certificates, and even the partial suspension of cash payment.

The general public had little direct experience of bank runs and bank suspensions during the National Banking era. However, when partial suspension of cash payment occurred, it brought home the realization of a banking panic to many people.

The proximate effects of partial suspension of cash payment included difficulties in meeting payrolls, dislocation of the domestic exchanges, an increase in hoarding, and the emergence of a currency premium. This disruption of the payments mechanism led to an increase in real transactions costs, temporary factory closings, layoffs, and the creation of currency substitutes.

During the Great Depression, banking panics were a significant issue. The banking panics of 1930 and 1931 were region specific, with only half of the Federal Reserve Districts experiencing significant bank closings or changes in hoarding.

The St. Louis Federal Reserve District was particularly affected, with two out of every five closings occurring there. In 1930, four Districts accounted for 80 percent of total bank suspensions.

The Chicago District was also a hot spot, with one-third of bank suspensions happening there between April and August 1931. This led to a mini panic in June and a full-scale panic in Toledo in August.

The Cleveland Federal Reserve District had two-thirds of the deposits of suspended banks, but six Districts saw little or no change in currency hoarding.

Readers also liked: Federal Bank Online Banking

A banking panic occurs when a large number of depositors withdraw their funds from banks simultaneously, often due to a loss of confidence in the banking system.

This can be triggered by a major bank failure, a significant economic downturn, or a series of bank runs.

In the US, the first recorded banking panic was in 1797, when a wave of bank failures led to a sharp decline in the money supply.

The Bank War of 1832-1833, led by President Andrew Jackson, also contributed to a banking panic by withdrawing federal funds from the Second Bank of the US.

The Panic of 1873 was caused by a combination of factors, including a stock market crash and a decline in international trade.

The banking panic of 1907 was triggered by a stock market crash and a wave of bank runs, leading to a significant decline in the money supply.

The Federal Reserve System was established in 1913 to provide a lender of last resort and prevent future banking panics.

Worth a look: Bank Runs Out of Money

The long era of banking disturbances finally ended in 1933, a significant turning point in the history of banking panics.

The introduction of deposit insurance played a crucial role in ending banking panics, as it provided a safety net for depositors and helped to restore confidence in the banking system.

Improved performance of the Federal Reserve also contributed to the end of banking panics, as it helped to stabilize the financial system and prevent future crises.

Knowledge alone, however, was not enough to prevent banking panics, as demonstrated by the fact that a better understanding of the sources of systemic banking unrest was also necessary.

Leadership and policymaker competence were found to be essential in preventing banking panics, highlighting the importance of effective governance in the banking sector.

Banking Panics in New York City were a common occurrence during the National Banking era.

In New York City, banking panics were marked by money market stringency, a stock market collapse, and loan and deposit contractions.

The general public in New York City had little direct experience of bank runs and bank suspensions, but the partial suspension of cash payment was a major issue.

Recommended read: 1994 Bond Market Crisis

This partial suspension of cash payment led to difficulties for business firms in meeting payrolls, and disruptions to the domestic exchanges.

Bankers in New York City were reluctant to make remittances, which encouraged firms to demand cash payment, thereby reducing real transactions.

The emergence of a currency premium was another consequence of the partial suspension of cash payment in New York City.

The disruption of the payments mechanism led to an increase in real transactions costs, temporary factory closings, layoffs, and the creation of currency substitutes.

You might enjoy: Problems with Td Bank Banking Payment System Complaints

Bank failures and suspensions were a common occurrence during banking panics. The number of bank suspensions varied across different panics and regions.

For example, during the Great Depression, the number of bank suspensions was highest in the 1931 panic, with 827 failures. In contrast, the 1930 panic saw 806 bank failures.

The St. Louis Federal Reserve District was particularly affected, with two out of every five closings occurring there. Four Districts accounted for 80% of total bank suspensions, and slightly over one-half of the deposits of failed banks.

Suggestion: 1907 Banking Panic

The number of bank failures also varied across different panics, with the 1893 panic seeing the highest number at 503. In comparison, the 1907 panic saw only 73 bank failures.

Here's a breakdown of the number of bank failures during different panics:

Bank failures were not limited to a single region, but were often concentrated in specific areas. For example, during the 1931 panic, three Districts (Chicago, Cleveland, and Philadelphia) accounted for two-thirds of the deposits of suspended banks.

The Great Depression was a time of great economic turmoil, and banking played a significant role in its severity. Banking panics were a common occurrence during this period.

One of the principal characteristics of banking panics is the increased number of bank runs and bank suspensions. The evidence does not permit an estimate of the number of all bank runs.

Table 1 shows the number of bank failures during the Great Depression.

The number of bank failures during the Great Depression was staggering. In November-December 1930, for example, 806 banks failed.

A banking panic can be a frightening experience, but understanding what it is and how it works can help alleviate some of the fear.

Banking panics are a type of financial shock that can have far-reaching effects on the economy.

They can be triggered by a sudden and unanticipated revision of expectations of deposit loss, where depositors try to convert their checking deposits into currency.

This can be a rational response to an asymmetric information deficit, where depositors don't have access to complete information about the bank's financial health.

Banking panics can be local, regional or national in scope, but their effects can extend beyond their geographical boundaries.

In the past, pre-1914 banking panics were mainly restricted to the New York money market, but they still had nonnegligible national effects on the money stock.

The effects of banking panics on expenditures and overall economic activity have been difficult to measure.

Each banking panic has its own unique characteristics, differentiating it from others in terms of its origins, duration, and response from authorities.

The New York Clearing House and the Federal Reserve have played a crucial role in responding to banking panics, but their responses have varied over time.