A financially healthy bank holds most of its assets in long-term loans and has only a fraction of its total deposits as cash on hand. A false rumor spreads that the bank is in financial trouble, causing a large number of depositors to rush to withdraw their money at the same time. The bank is unable to meet all the withdrawal demands and is forced to close. Which statement best analyzes the fundamental reason for the bank's failure in this scenario?

Bank Liquidity and Depositor Confidence

The Paradox of Bank Runs

The Bank Run Mechanism

A bank run can only cause a bank to fail if the bank was already financially unsound (e.g., insolvent or holding bad loans) before the run began.

Arrange the following events in the correct chronological order to illustrate how a bank run can become a self-fulfilling prophecy, even for a financially sound bank.

Match each component of a self-fulfilling bank run with the role it plays in the process.

A bank run is considered a self-fulfilling prophecy because the very ______ of a potential bank failure can trigger a mass withdrawal of deposits, thereby causing the feared outcome to occur.

A bank holds a large portfolio of long-term, profitable loans but keeps only a small fraction of its deposits as cash. A widespread, unfounded rumor causes many depositors to worry about the bank's ability to pay them back. You are a depositor at this bank. You have investigated and are certain the rumor is false and the bank is financially healthy in the long run. However, you observe long lines forming outside the bank's branches. Based on an understanding of how the banking system functions, what is your most financially rational course of action?

Evaluating a Policy Response to a Bank Run