In this article, I will provide details on bank runs, including definitions of terms related to the phenomenon, and thereafter provide a comparison between relevant bank runs when one looks at modern day economies. The first bank runs to be discussed are two that occurred in Japan during the late 20th century, which will help to explain that bank run phenomena can be caused by different underlying factors. The second bank run to be discussed would be the Northern Rock bank run. Let us begin.
What is a bank run?
According to Dictionary.com, a bank run can be defined as the concerted action of depositors who try to withdraw their funds from a bank because they believe that the bank will fail. If a bank cannot guarantee the safe keeping of the funds that belong to its clients, then it is only reasonable that clients take on this responsibility in a personal capacity.
In order to safe guard against this type of behavior, central banks typically require that financial institutions such as banks keep a minimum reserve of their deposits on hand, in the event that customers require their monies. This also helps to prevent these institutions from taking on excessive risk or leverage, which would be detrimental to their financial well-being. The soundness and financial health of banking institutions is a matter of international interest that is coordinated via the Basel Accords.
Bank Runs in Japan—Late 1900s
Toyokawa Shinkin Bank
The first bank run to be discussed would be the one that occurred at the Toyokawa Shinkin bank. An interesting detail about this particular bank run would be that it was caused by rumor started by three Japanese high school students! These students began joking around about the solvency of the Toyokawa Shinkin bank. Their jokes were centered around claims that the bank was ineffectively managed. Their jokes achieved more than the giggles they had initially intended, and like the boy who cried wolf, things got serious really quickly! Fortunately for Toyokawa Shinkin bank, senior figures at the Tokai Bureau of Finance and the Bank of Japan guaranteed sound management, and this effectively settled the bank run.
Toyo Shinkin Bank
In the case of the Toyo Shinkin Bank, lawlessness was the underlying factor that led to bankruptcy. One of the branch managers of the Toyo Shinkin Bank and an owner of a particular restaurant conspired to issue falsified certificates of deposit. These falsified deposits were then used to obtain a loan of up to 350 billion yen from Japan’s non-bank banking sector! The two individuals were later arrested for collusion regarding forgery.
The owner of the restaurant had made a fortune during the boom of the late 1980s in Japan, but experienced some losses when the bubble burst in the early 90s. In order to recuperate some of her losses, the restaurant owner solicited the owner of the bank to aid her in the delinquent action of forging the certificates of deposit. When other customers found out about this particular incident, bank runs began occurring at multiple branches of the Toyo Shinkin Bank.
In order to continue with operations, the Toyo Shinkin Bank required a restructuring of its balance sheet. Beyond this restructuring, Fuji Bank and the Industrial Bank of Japan abandoned the respective debts they had with the Toyo Shinkin Bank in order help calm the disorder caused by the bank run.
Northern Rock and the Great Recession
History of Northern Rock
Northern rock was formed as the result of a combination between two building societies, namely the Rock Building Society and Northern Counties Permanent Building Society. Most of us who watch Premier League Soccer are familiar with the bank, or rather the name of the bank, because it was the Sponsor for Newcastle United from 2003 up until 2011. According to the value of the bank’s mortgage assets, Northern Rock was the fifth largest bank in the United Kingdom at the time of its collapse.
Failure of Northern Rock
Northern Rock was the bank most heavily involved in securitized products leading up to the Great Recession of 2008, when one looks at all of the banks in the United Kingdom during this time. Securitization can be defined as the pooling of various types of contractual debts such as mortgage loans, student loans, and auto loans amongst others.
Securitization became a problem during the buildup to the Great Recession because of the issuance of Subprime Mortgages, which eventually became part of securitized products called Collateralized Debt Obligations. Subprime mortgages are loans which are given to individuals who do not have the requisite credit score in order to obtain loans. These loans were taken out by a great number of individuals, and in the process a lot of private lenders made substantial profits.
These loans were associated with the growing Real Estate Market in global economies, which was booming from the late 90s up until 2007. When subprime mortgage lenders do not repay their debt obligations, which form part of the income streams of banks like Northern Rock, these banks have less liquidity to service their operations and thus encounter liquidity problems.
Another important point to mention explicitly would be that loans taken out by individuals and businesses with a bank, are assets of the bank. It is therefore intuitive that the when individuals and businesses do not repay these loans, that there is a decline in the value of the bank's assets. This is exactly what happened when one considers the case of Northern Rock during 2007. Northern Rock requested a liquidity support facility from the Bank of England to better manage the crisis it was facing. This resulted in a panic among the customers of the bank, which eventually resulted in a bank run.
Concluding Remarks
This article shows that bank runs can be caused by a variety of issues. As such, one should keep an open perspective when looking for a smoking gun when investigating such incidents. Although some causes are a bit more humorous than others, the financial impact is no laughing matter. Regulators should monitor all potential causes of such phenomena in order to keep them from occurring; this will aid the the stability of financial institutions in global and local economies. Complement this article with the following video.
Resources,
Bank Run definition, Dictionary.com
Minimum Reserve Requirement, Wikipedia.com
History of the Basel Accords, BIS.com
What is Securitization?, Investopedia.com
Northern Rock, ChronicleLive.co.uk
Tokoyawa shinkin bank, Essential Countermeasures for Bank Runs[Research Paper]
toyo shinkin bank, Essential Countermeasures for Bank Runs[Research Paper]
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