<p>Ordinary people can't tell if bank is just liquid or insolvent. Often even experts might not be sure if the bank is iliquid or
insolvent during an ongoing crisis.</p>
<p>Consider the following mini-game. If the bank is solvent depositor can keep their money in the bank and gets pay-off 2, which represents their benefit
in terms of money, and time saved from looking for new bank. If the bank is solvent and they withdraw their money they only get pay-off 1 from their money
if the bank is insolvent and they do not withdraw their money they get nothing, and if it is insolvent but they withdraw their money they get 1.</p>
<p>What should in this case depositor do? In this case if depositor believes that the probability of bank being insolvent is &gt;50% they should withdraw their money from the bank (because at that probability they get larger expected benefit from withdrawing money from the bank than from keeping them in).
If you get sufficient mass of people who think it is probable bank is insolvent, then it becomes self-fulfilling and you get a run on a bank.</p>
<p><span class="math-container">\begin{array}{|c|c|c|c|}
\hline
\text{Depositor 1 \ Bank 2}  &amp; \text{Solvent}   &amp;  \text{Insolvent}  \\\hline
\text{Withdraw} &amp; 1 &amp; 1 \\\hline
\text{keep} &amp; 2 &amp; 0 \\\hline
\end{array}</span></p>

CC BY-SA 4.0
2024-10-31T08:57:55.313Z
2024-10-31T08:57:55.313Z
Lorenzo Pozzi
<p>I never understood why people panic during a bank run. The bank would become temporarily cash flow insolvent, not balance sheet insolvent so everybody should be able to receive their funds back. What's the problem?</p>

CC BY-SA 4.0
2024-10-30T13:24:45.403Z
Historically, many banks failed because of bank runs, even in 2023, see https://cepr.org/voxeu/columns/addressing-banks-vulnerability-runs-part-1-facts-arguments-and-policy-challenges. So your theory doesn't hold.
AKdemy
<banking>
Why do bank runs lead to bankruptcy?
JobHunter69
# Why do bank runs lead to bankruptcy?

(Asked by: username_0 on 2024-10-29)

I never understood why people panic during a bank run. The bank would become temporarily cash flow insolvent, not balance sheet insolvent so everybody should be able to receive their funds back. What's the problem?

**Tags:** banking
> **Comments:**
> **username_1**: Historically, many banks failed because of bank runs, even in 2023, see https://cepr.org/voxeu/columns/addressing-banks-vulnerability-runs-part-1-facts-arguments-and-policy-challenges. So your theory doesn't hold.  

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## 1 answers

### Answer by username_2 on 2024-10-31. Score: 2

Ordinary people can't tell if bank is just liquid or insolvent. Often even experts might not be sure if the bank is iliquid or
insolvent during an ongoing crisis.

Consider the following mini-game. If the bank is solvent depositor can keep their money in the bank and gets pay-off 2, which represents their benefit
in terms of money, and time saved from looking for new bank. If the bank is solvent and they withdraw their money they only get pay-off 1 from their money
if the bank is insolvent and they do not withdraw their money they get nothing, and if it is insolvent but they withdraw their money they get 1.

What should in this case depositor do? In this case if depositor believes that the probability of bank being insolvent is >50% they should withdraw their money from the bank (because at that probability they get larger expected benefit from withdrawing money from the bank than from keeping them in).
If you get sufficient mass of people who think it is probable bank is insolvent, then it becomes self-fulfilling and you get a run on a bank.

\begin{array}{|c|c|c|c|}
\hline
\text{Depositor 1 \ Bank 2} & \text{Solvent} & \text{Insolvent} \\\hline
\text{Withdraw} & 1 & 1 \\\hline
\text{keep} & 2 & 0 \\\hline
\end{array}


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