Moreover, a bank run at one bank often triggered a chain reaction of runs on other banks. In the late nineteenth and early twentieth century, bank runs were typically not the original cause of a recession—but they could make a recession much worse. To protect against bank runs, Congress has put two strategies into place: deposit insurance and the lender of last resort. Deposit insurance is an insurance system that makes sure depositors in a bank do not lose their money, even if the bank goes bankrupt.
About 70 countries around the world, including all of the major economies, have deposit insurance programs. Banks pay an insurance premium to the FDIC. Bank examiners from the FDIC evaluate the balance sheets of banks, looking at the value of assets and liabilities, to determine the level of riskiness.
The FDIC provides deposit insurance for about 6, banks as of the end of Since the United States enacted deposit insurance in the s, no one has lost any of their insured deposits. Bank runs no longer happen at insured banks.
The problem with bank runs is not that insolvent banks will fail; they are, after all, bankrupt and need to be shut down. The problem is that bank runs can cause solvent banks to fail and spread to the rest of the financial system. To prevent this, the Fed stands ready to lend to banks and other financial institutions when they cannot obtain funds from anywhere else. This is known as the lender of last resort role.
For banks, the central bank acting as a lender of last resort helps to reinforce the effect of deposit insurance and to reassure bank customers that they will not lose their money. The lender of last resort task can come up in other financial crises, as well.
During the panic of the stock market crash in , when the value of U. A bank run occurs when there are rumors possibly true, possibly false that a bank is at financial risk of having negative net worth.
As a result, depositors rush to the bank to withdraw their money and put it someplace safer. Central Banks. Introduction to the Fed. The Fed's Roles and Functions. Table of Contents Expand.
The Federal Reserve Board. Office of Thrift Supervision. State Bank Regulators. State Insurance Regulators. State Securities Regulators. The Bottom Line. Key Takeaways Regulatory bodies are established by governments or other organizations to oversee the functioning and fairness of financial markets and the firms that engage in financial activity.
The goal of regulation is to prevent and investigate fraud, keep markets efficient and transparent, and make sure customers and clients are treated fairly and honestly. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.
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What Is the Volcker Rule? We use analytics cookies so we can keep track of the number of visitors to various parts of the site and understand how our website is used.
For more information on how these cookies work please see our Cookie policy. People and businesses can lose money they have placed with the bank. This can mean they also lose confidence in banks so are unwilling to bank with them again.
It can also disrupt the services that banks provide to customers. For example, payments systems — you might not be able to use your account for a while if your bank failed. When banks fail, they can also make it more likely that other banks will, too. The financial crisis showed that problems can spread from one bank to another, like a fire spreading. The crisis wreaked havoc on the rest of the economy.
An example of this is the Senior Managers Regime which makes sure that senior bankers are held accountable for their decisions. Regulation also makes banks hold shock absorbers to help deal with bad investments. These shock absorbers are referred to as capital. Regulation is used to make it less likely people will take out their money unexpectedly. Banks also have to hold cash or assets that can be sold very quickly to cover unexpected withdrawals.
This should help make bank runs less likely. That's why strong financial regulation is important - to put rules in place to stop things from going wrong, and to safeguard the wider financial system and protect consumers if they do go wrong.
Ensuring firms have the funding to trade safely, have the appropriate risk controls in place and are appropriately governed is known as "prudential regulation". Ensuring firms treat customers fairly from the sales process to how complaints are managed, is known as "consumer protection". An important part of prudential regulation is authorisation. We call this our "gatekeeper role" and means we only allow firms to operate in the financial system once they have fulfilled a number of criteria, including governance and risk control.
Consumer protection rules are also in place. These spell out how firms must treat their customers when selling them financial products. So for example, a regulated firm must ensure that it "acts honestly, fairly and professionally in the best interests of its customers and the integrity of the market".
To make sure firms abide by the rules of regulation, they have to be supervised. Our supervision work is intrusive, and allows us to monitor financial service providers to make sure they are following the rules. Central Bank staff review and report on all aspects of firms' businesses to judge whether they are being run in a safe and sound manner. They also go on-site in firms to meet key decision-makers and inspect aspects of the business.
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