Question

ABC Bank is facing a financial crisis due to the simultaneous run of customers to the bank to convert their deposits in cash. With this situation, explain in your own words the reasons that drove the depositors to act in such a way. Assume you’re a top manager at the bank; explain what are the options that the management has that will save them from being insolvent due to the massive withdrawals.

Answer 1

The situation that is described is called " Bank Run"

Bank Run happens when bank customers loose faith in the bank and thinks that the bank will be insolvent. It is caused by panic. The trigger for Bank Run could be for many reasons like there was robbery in bank, NPA(Non Performing Asset) of bank is going out of hand, death of the CEO or any other factor. Clients start to think that the bank will collapse now, so everybody starts to withdraw money. The main operation of a bank is to give loan from the deposits it has. So the money is already given as loan and if suddenly all the clients start to withdraw money, then the bank will definitely collapse.

What should management do in case of Bank Run:

- Close the bank for some period and start making public disclosures regarding the safety of the clients money. Government should also participate in disclosing the correct information to the clients.

- Bank should start borrowing from other banks to meet the sudden liquidity requirement. If bank fails to pay clients, then it will default. So to prevent that from happening, they will have to borrow and give money to clients.

-The deposits received from the clients can be insured by government or third party. This help clients to have faith in their deposits