Banks and financial institutions manage money for most businesses and individuals. Banks make money available to customers through loans and withdrawals. A bank panic is a situation in which the majority of bank customers withdraw all the money from a bank. This can cause a complete bank failure because the banking system assumes only a certain percentage of money deposited in a bank will be available for existing accounts.
Banks are required to keep a specific reserve on hand in the event of a massive withdrawal situation. The amount of this reserve is set by a formula based on the amount of money deposited in the bank. It is set by the government to ensure banks don’t misuse the money deposited with their institutions. In the United States, the reserve percentage is adjusted by the federal government each year but is typically between three and ten percent of annual deposits.
With such a small reserve available, it is easy to see how a bank panic can cause instability in the banking system. If more then ten percent of the customers of all banks close accounts, it could cause the banks to run out of money. This makes the banks rely on the government for loans to cover any extra withdrawn amount, which quickly leads into a panic situation.
The last large bank panic in the United States was during the Great Depression. At this time, most consumers were afraid the banks would fail and their savings would be lost. This caused many banking customers to panic and make a run on the bank. Banks could not withstand the volume of withdrawals and were forced to close. This caused a vicious cycle because as banks were failing, more panic rose and more banks began to fail.
During recessions, it is important to keep consumers calm and set proper expectations about the financial industry's stability. If the government can reduce the public's fear, officials can limit the risk of a bank panic. Banks have plenty of money available, but most of it is tied up in loans and other financial obligations. A standard small withdrawal is what the banks expect, which is why they only have a specific reserve on hand.
During the recession of 2009 and 2010, many banks in the United States became unstable due to a small bank panic. This was quickly addressed by the United States federal government, which added money supply into the banking system. During this time, many banks collapsed, but the financial stability of the country remained intact.
