Are Bank Runs Contagious ?

Banks are a vital part of the economy because they provide an important channel through which many businesses get their financing. However, as we know from the history of the United States and other countries, banks can be subject to runs and panics. A panic that encompasses a large part of the banking system can seriously disrupt economic activity. During a run, a bank experiences much heavier demand for deposit withdrawals than it can easily meet. If the run is severe enough, the bank will not be able to meet the demands of all depositors trying to withdraw money and, consequently, will have to suspend payments. During a panic, runs occur on a large number of banks. Panics may occur because of regional or economywide problems, such as a real estate bust, during which the portfolios of many banks lose value. If depositors have not completely lost confidence in the banking system, they will transfer their deposits from failing banks to solvent banks. But panics may also occur because runs on a few banks cause depositors at other banks to lose confidence and, therefore, to withdraw indiscriminately from both solvent and insolvent banks. These types of panics, which involve runs on a few banks spreading to otherwise solvent banks, are said to involve contagion.