Can a run really kill a healthy bank?

In the model, yes: because banks fund long-term loans with money repayable on demand, a stampede can bankrupt an institution whose assets are sound. In practice most historical runs hit banks that were already weakened, and the run then converted weakness into certain failure. Both halves matter.

Why does deposit insurance work even when it rarely pays out?

Because its job is to change beliefs, not to move money. If no depositor can lose by waiting, no depositor gains by running, so the run never starts. The guarantee that is never used is the guarantee working exactly as designed.

What did the Panic of 1907 change?

It convinced Congress that the country could not keep depending on private financiers to stop panics, leading to the Federal Reserve Act a few years later. The 1930s failures then added the second pillar, federal deposit insurance, in 1933.

finance · 1907 and the 1930s

The Run That Makes the Bank Fail

A bank can be killed by nothing more than the belief that other depositors are about to kill it. The panics of 1907 and the 1930s taught the cure: change the belief.

Facts drawn from archival and scholarly records, including Federal Reserve historical essays; model results are labeled as modeled.

In October 1907, a failed attempt to corner a copper-mining stock touched off runs on the New York trust companies connected to the schemers, and the panic jumped from institution to institution on rumor alone. There was no central bank and no deposit insurance. The panic was contained when private actors, led by J. P. Morgan, pooled reserves, backstopped teetering institutions, and made the backing conspicuous, and the episode's lesson led directly to the creation of the Federal Reserve a few years later.

The Great Depression brought the run dynamic back at national scale, as waves of bank failures in the early 1930s destroyed savings and deepened the collapse; Ben Bernanke's later research argued the failures themselves prolonged the Depression by wrecking the credit system. Congress answered with the Banking Act of 1933, which created the Federal Deposit Insurance Corporation. Temporary federal coverage of 2,500 dollars per accountholder took effect on January 1, 1934, and permanent coverage of 5,000 dollars followed that July [VERIFIED]. The runs on insured deposits largely stopped.

Play the same structure: The Teller Line.

Sources

[VERIFIED] The Diamond-Dybvig model: multiple equilibria and deposit insurance as equilibrium selection Diamond and Dybvig, "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, vol. 91, no. 3, 1983
[VERIFIED] The 2022 Nobel Memorial Prize to Diamond, Dybvig, and Bernanke for research on banks and financial crises Nobel Prize press release, October 2022
[VERIFIED] The Banking Act of 1933 created the FDIC Federal Reserve History, "Banking Act of 1933 (Glass-Steagall)"
[VERIFIED] The Panic of 1907: trust-company runs contained by pooled private reserves Federal Reserve History, "The Panic of 1907"
[VERIFIED] Depositors withdrew 42 billion dollars from Silicon Valley Bank on March 9, 2023 Fortune, reporting on the March 2023 Silicon Valley Bank run
[VERIFIED] History of federal deposit insurance coverage amounts from 1934 onward Bankrate, "A Brief History of FDIC Limits"