BANK RUN AND LIQUIDITY POSITION at IOB

What is BANK RUN AND LIQUIDITY POSITION?

A situation that a bank or financial institution faces when its liquidity drops down due to an irregular increase in concurrent withdrawals by customers/ accountholders.

Overview

During a bank run, a large number of depositors lose confidence in the security of their bank, leading them all to withdraw their funds at once. Banks typically hold only a fraction of deposits in cash at any one time, and lend out the rest to borrowers or purchase interest-bearing assets like government securities.

Frequently Asked Questions

What is a bank’s liquidity?

Liquidity is the risk to a bank’s earnings and capital arising from its inability to timely meet obligations when they come due without incurring unacceptable losses. Bank management must ensure that sufficient funds are available at a reasonable cost to meet potential demands from both funds providers and borrowers.

What is an example of a bank run?

A bank run that emanates from public fear and that pushes a bank into actual bankruptcy is an example of a self-fulfilling prophecy. As more people withdraw money, the risk of bankruptcy increases and this triggers even more withdrawals.

Why do banks need liquidity?

Cash reserves are about liquidity. Banks need capital in order to lend, or they risk becoming insolvent. Lending creates deposits, but not all deposits arise from lending. Banks need funding (liquidity) when deposits are drawn, or they risk running out of money.

Can a bank run happen today?

No. Even with full government insurance, as in the case of the FDIC and IndyMac, your account could be tied up in red tape whereas you need the money now. In the case of Greece, deposits in non-Greek banks may be small consolation for those who need ready cash.

How are bank runs avoided?

If banks are unable to take out enough cash from their branch, they can borrow the money from other institutions; thus, avoiding the situation of going bankrupt. If the threat of a bank run is there, institutions can opt for shutting down for a specified period.

How do banks get liquidity?

Banks deal with their inherent illiquidity first and foremost through borrowing and lending in the interbank market. At any given point in time, some banks will need liquidity while others will have extra, and liquidity is distributed between them using short term, typically overnight, loans.

How do banks manage liquidity?

Banks maintain their liquidity profile through a reserve of liquid assets, which include government bonds and management of liabilities. A component of liability management is the maturity ladder or profile.

What is liquidity with example?

Liquidity refers to how easily an investment can be sold for cash. T-bills and stocks are considered to be highly liquid since they can usually be sold at any time at the prevailing market price. On the other hand, investments such as real estate or debt instruments and illiquid assets trade at a discount.

Are bank runs Illegal?

Many states have laws on the books to try to prevent rumor or malicious speech from causing runs on the banking system. Many states have laws on the books prohibiting anyone from making disparaging comments about a particular bank’s financial condition.

Why is a bank run so difficult to stop?

As a bank run progresses, it generates its own momentum: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals. This can destabilize the bank to the point where it runs out of cash and thus faces sudden bankruptcy.

Which description best fits the definition of bank run?

A bank run is a situation in which depositors race to the bank to withdraw their deposits for fear that otherwise those deposits would be lost.

Does bank run always lead to bank panic?

Explain how a bank run can turn into a bank panic. Bank runs occur when people fear that their bank has become insolvent. Depositors rush to their bank to withdraw their funds. Depositors at other banks become concerned about their own bank’s solvency, so they also hurry to withdraw their funds.

Who can tell which banks will fail?

In contrast, the interbank market precisely identifies which banks will fail: the interbank market collapses for failing banks entirely but continues to function for surviving banks, which can borrow from other banks in response to deposit outflows.

What is liquidity simple words?

Liquidity refers to the ease with which an asset, or security, can be converted into ready cash without affecting its market price. Cash is the most liquid of assets, while tangible items are less liquid. The two main types of liquidity include market liquidity and accounting liquidity.

How is bank liquidity measured?

The core of this new requirement is the liquidity coverage ratio, or LCR. This ratio is calculated by dividing a bank’s high-quality liquid assets, or HQLA, into its total net cash over a 30-day period. This ratio must be 100% or higher for banks to be compliant with the regulation.