A bank run is the ultimate collective action problem in finance: an event that is irrational at the individual level but rational for each individual given what others are doing, which can destroy a solvent institution in days. Understanding the dynamics of bank runs — and why they spread — illuminates one of the deepest structural vulnerabilities in the financial system.
The structural cause is maturity mismatch. Banks fund themselves short-term (deposits withdrawable on demand) and invest long-term (mortgages, business loans). They hold only a fraction of deposits in liquid form. This is profitable and socially useful — it provides financing for long-term investment while giving depositors liquidity — but it means banks are never in a position to return all deposits simultaneously.
The trigger for a bank run is usually a loss of confidence — a rumour, a news story, a visible sign of distress. If depositors believe a bank might fail, each depositor's rational response is to withdraw immediately, before the bank's reserves are exhausted. If everyone acts on this belief simultaneously, the bank does fail — because even a sound bank cannot liquidate its loans fast enough to meet mass withdrawal demand. The belief is self-fulfilling.
The original Diamond-Dybvig model (1983, Nobel Prize 2022) formalised this dynamic mathematically, showing that bank runs are an equilibrium outcome — a coordination failure, not necessarily a response to genuine insolvency.
Bank runs spread through several mechanisms. Direct contagion: if one bank fails, depositors at related or similarly positioned banks fear they are next. Information contagion: when one bank fails under circumstances that seem to apply to others, uncertainty about which banks are safe drives preemptive withdrawals across the sector. Fire sale contagion: a failing bank liquidating assets at distressed prices pushes down asset values, impairing other banks that hold similar assets on their books.
Modern banks benefit from deposit insurance (breaking the trigger for retail runs) and central bank lender of last resort facilities (providing emergency liquidity). But sophisticated depositors above insurance limits — as Silicon Valley Bank's tech-company depositors were in 2023 — remain vulnerable, and modern digital banking allows runs to occur at speeds that give banks almost no time to respond.