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Deposits can be withdrawn on demand, but mortgages and business loans run for years. This maturity transformation is what banks are for, and it means no bank holds enough cash to repay everyone at once. Note: lending itself creates new deposits rather than passing on existing ones, but banks still need liquid reserves to meet withdrawals and payments.
Insolvent: assets are worth less than liabilities. Illiquid: assets exceed liabilities but can't be turned into cash fast enough. A run can kill a perfectly solvent bank — watch the loans sitting untouched while the vault empties.
Diamond and Dybvig (1983) showed a bank has two equilibria. If everyone trusts it, nobody runs. If you think others will run, it's rational to run first, because withdrawals are paid first-come, first-served. Belief creates the failure.
Deposit insurance (UK FSCS: up to £120,000 per eligible depositor, per authorised firm, since 1 Dec 2025; brands sharing one banking licence share one limit) greatly reduces the incentive to run, though it does not remove it entirely. The lender of last resort lends cash against good collateral. Walter Bagehot's 1873 rule: lend freely, at a high rate, against good collateral.
You are the CEO. Each round brings news that moves depositor confidence. You get 2 action points a round to raise cash or calm nerves — then the depositors decide. Run out of cash and you fail (illiquid). Let equity fall below zero and you fail (insolvent). Survive every round to win.
Think as you play: does each action improve liquidity, solvency or confidence, or one at the expense of another? The debrief at the end will ask you.
Balance sheets are scaled so total assets start at 100bn, making the three banks easy to compare. Events are simplified versions of what really happened.
Name: ______________________ Class: ________ Date: ____________
Bank run: a large number of depositors try to withdraw their money at the same time because they fear the bank will fail.
Liquid reserves: banks hold only a small fraction of their deposits as cash and central bank reserves. No bank can repay all depositors at once.
How lending really works: the models in this resource simplify by showing deposits being "lent out". In practice, when a bank makes a loan it creates a new deposit for the borrower (Bank of England, 2014). Banks still need enough liquidity to meet withdrawals and payments to other banks, and a run drains that liquidity.
Maturity transformation: banks borrow short-term (deposits repayable on demand) and lend long-term (mortgages, business loans). This creates a liquidity mismatch.
Liquidity vs solvency: a bank is insolvent if its assets are worth less than its liabilities (negative equity). It is illiquid if it is solvent but cannot turn assets into cash quickly enough to meet withdrawals. Runs can bring down solvent banks.
Liquidity vs profitability trade-off: cash reserves earn little; loans earn more. Banks that hold too little cash are more profitable in calm times but more fragile.
Self-fulfilling expectations (Diamond–Dybvig, 1983): because withdrawals are paid first-come, first-served, it is individually rational to run if you expect others to run — even if the bank is sound.
Fire sale: selling assets quickly, at below their true value, to raise cash. Fire sales turn liquidity problems into losses that can make a bank insolvent.
Contagion and systemic risk: a run on one bank can spread to others perceived to be similar, threatening the whole financial system.
Northern Rock funded around three-quarters of its mortgage lending by borrowing in wholesale money markets rather than from retail deposits. When BNP Paribas froze funds exposed to US sub-prime mortgages on 9 August 2007, interbank lending dried up. On 13 September the BBC reported the bank had sought support from the Bank of England, which announced emergency liquidity support on 14 September. Queues formed outside branches from 14 to 17 September — the first UK bank run in roughly 150 years. Deposit protection at the time covered 100% of the first £2,000 and 90% of the next £33,000, so savers still had reason to run. On 17 September Chancellor Alistair Darling guaranteed all existing deposits and the queues stopped. Northern Rock was nationalised in February 2008.
SVB's deposits came largely from tech start-ups and venture-capital funds, and around 94% were above the US $250,000 insurance limit. It invested heavily in long-dated government bonds when yields were low. As the Federal Reserve raised rates through 2022, those bonds fell in value. On 8 March 2023 SVB announced it had sold $21bn of securities at a $1.8bn loss and planned to raise $2.25bn in new capital. Venture-capital investors told portfolio companies to move their money; about $42bn was withdrawn on 9 March, with more queued for the next day. Regulators closed the bank on 10 March. On 12 March US authorities guaranteed all SVB deposits, and on 13 March HSBC bought SVB UK for £1. The run was faster than Northern Rock's because depositors were concentrated, uninsured, connected by group chats and able to withdraw on their phones.
Pick one action you took in Run the Bank. Did it improve liquidity, solvency, confidence, or one at the expense of another? Was the trade-off worth it at that point in the crisis?
1. Explain the difference between a bank being illiquid and being insolvent. [4 marks]
2. Using an example, explain why a bank run can be described as a self-fulfilling prophecy. [6 marks]
3. Evaluate whether raising the deposit insurance limit is the best way to prevent bank runs. [15 marks]