Question

Why is it that a run on a single bank can turn into a widespread financial panic, or what the text identified as contagion?

Answer 1

The economy of any country runs in a circle, there are various participants of economy and all of them should be properly linked along with walking in tandem for good health of the economy. Banks, can be said as the backbone of economies around the world, they take money from general public and give it to those who are in need of it for productive purposes. All banks, as per policies of central bank and government are linked with each other, they lend and borrow to each other, and thus run of a particular bank would mean a strain on the balance sheets of various other banks as well. Also, if the news of bank run reaches to layman retail depositors through media etc. then it becomes a cause of widespread panic among people. The retail investors will run to withdraw deposits from every bank assuming that all banks may went bankrupt, this would lead to a complete collapse of financial system and economy in general. Therefore, the main cause of this panic is interlinking of financial systems and greater access of information to people through media and newspapers which can cause high level of panics among people in a very short time.