Question

What is the relationship between a bank run and liquidity risk? (15 marks )

Answer 1

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Bank run is when large number of depositors withdraw money from bank. Bank generally have only part of its reserves as liquidated. When more and more depositors withdraw, there is would be an increased risk that the bank may default since it won't have enough cash to provide to the withdrawers. This triggers more concern among depositors and like a self-fulfilling prophecy, more depositors start believing that the bank is failing, leading to further panic withdrawal, leading  to liquidity crisis. Thus bank run increases liquidity risk