Preventing (panic) bank runs

Abstract

We study experimentally an instrument to prevent bank runs in healthy banks. In particular, we extend the basic bank-run game, where depositors choose between withdrawing or keeping their money deposited, with a third option, the possibility to relocate funds to a priority account that is less profitable, but which guarantees a payoff even in a bank run. Theoretically, the use of this instrument dominates withdrawals for depositors without liquidity needs, and given this fact, depositors should optimally keep their deposits in the bank, so no bank run shall happen. In our experiment, we find evidence that the mechanism reduces not only bank runs that occur because of a coordination problem among depositors, but also panic bank runs that occur when depositors can observe the action of others. However, its effectiveness is limited and depositors seem not to recognize the protection it provides.