Good morning! Let's talk bank runs and bank failures, since we've seen a few recently. I'll explain how it happens.

As the headline indicates, I'll explain things in simple terms for you. Not that you're dumb or anything — well, statistically speaking, some of you are, since millions of people read this website every month ... but, yeah, never mind. I shouldn't have said that. Onward.

First, if you don't know what a bank run is, it's when a bunch of people withdraw their money (or try to withdraw their money) from a bank at the same time because they think the bank is in trouble and might fail in the near future. Some of you have no doubt done this exact thing in the past month.

To understand how a bank run leads to a bank failure, it's important to understand how banks actually work.

When you deposit money in a bank — many people don't know this — they don't actually keep your money in the bank. They don't go stick all of it in a big vault in the back. They only really keep a small fraction of your money at all. They loan out and invest the rest of it, and get a much higher rate of return than what they pay you. That's the main way banks make money. This is called fractional-reserve banking.

So guess what? If enough people show up to withdraw their money, any bank can quickly run out of cash reserves, since they only actually keep a fraction of customer deposits. If it's only a normal amount of customers withdrawing an average amount of money, no big deal. But if a bank gets a sudden influx of customers withdrawing funds, things can go south very quickly.

➡️ And as more people withdraw their cash...

➡️ the actual likelihood of that bank failing increases...

➡️ which leads to more fear among customers...

➡️ which makes more people show up to withdraw their cash...

➡️ until...

Here's a good infographic from Statista that shows how "perceived or actual weakness" in a bank can quickly turn into a death spiral:

I hope this explainer was informative and enjoyable. Have a lovely day.