One of the main themes in the coverage of the Northern Rock story is that customers have been acting irrationally in wanting to draw money out from the seemingly ailing bank. This is particularly rich from people working in the financial markets, who must already realise that it is often perfectly rational to move with the crowd. Especially if you lack sufficient clout to polarise the market in your favour, there is little choice, except to avoid risk.
FOLLOW THE CROWD
Raw fear and crowd psychology appear to play a big part in whipping up a seemingly unstoppable tidal wave of panic when a bank run takes hold. “If a crowd is heading in one direction, people are loathe to go the other way. In a world of uncertainty often the best thing is to follow the crowd,” said Avinash Persaud, a risk consultant who heads Intelligence Capital.
With certainty, if everyone decides to draw their money out of the Bank it is going to cause it problems (even if it borrows the majority of it’s money from other banks it needs some assets of it’s own one, i think it’s safe to assume!). If I have little to lose by moving my money to another bank why wouldn’t I do that?
Money in savings account is meant to be a low risk investment, people can’t afford to lose these savings, otherwise they would be more likely to have invested them in stocks shares or housing (especially with the rise of the buy-to-let phenomenon triggered by the [previously] low cost of borrowing). So it is perfectly rational to draw your money out of an ailing bank (perhaps losing a few months interest ~0.3%?) to avoid the chance of losing in the best case 10% and spending who knows how long getting it back, or perhaps all of your money.
Since the `Run on Northern Rock’ the government was forced to step in to support the bank, in the hope of preventing a similar fiasco at any of the other banks. The panic was initially caused by the announcement by the Bank of England changed it’s position and said that it would support Northern Rock. The announcement was met with the same level of skepticism that as when the director of a football club saying he fully supports the manager. The public started drawing out their money, and only stopped after the government said it would guarantee that they wouldn’t lose any of their cash.