Bank Run, Depositors and Game Theory

Recently a Mumbai based cooperative bank was in news for lending huge amount of money to 2-3 industrialists who had closed their business and had disappeared with the money. What was left with bank was inventory worth few lakhs. There was panic among depositors who rushed to various branches of bank to withdraw their money.

 

Now questions is should bank allow depositors to withdraw their money or ask them not to withdraw amount. Allowing depositors to withdrawing money will increase faith of depositors but high withdrawals may also create problem of insolvency.

Game Theory offers interesting solution in case of Bank run. If all depositors do not withdraw amount and give bank enough time to tide over crisis, then payoff is highest, they can get their money with interest. But if all withdraw then due to insolvency each will end up getting lesser amount. But if one withdraws and other doesn’t, then one who withdraws gets more than one who does not withdraw.

A bank run occurs when a large number of customers of a bank or another financial institution withdraw their deposits simultaneously due to concerns about the bank’s solvency. This has been happening for decades. Many depositors have lost their life time savings in bank run.

Sometimes number of banks may face this problem due to national level financial crisis ex. Grexit.

Coming back to our story in case of this Mumbai based cooperative bank, the Reserve Bank of India decided to intervene to avert the crisis and asked depositors to withdraw money in a staggered manner ex. not more than Rs.10000 in 6 months.