Bank Run Model: The Application of Game Theory

Abstract

The term "bank run" describes the mass withdrawal of funds from a bank by its customers. With cash on hand, the bank might be able to handle the situation. As more consumers pull their money out of the company's bank accounts, the likelihood of the business collapsing increases. Based on this, this paper studies the bank run in game theory. It was found that: within the framework of game theory, this situation might be represented as a "coordination game," the latter being a kind of game with two distinct and stable equilibrium states: If enough people keep their money in the bank, the bank won't be able to default on its responsibilities, thus keeping your money there makes sense. On the other hand, if many customers withdraw their deposits, the bank will collapse, and at that time, it is logical for all of the customers to seek to withdraw their money. To clarify the phenomenon of bank runs, this study will use the Diamond-Dybvig model. This theory holds that a bank's primary function is facilitating long-term loans for investment purposes and short-term deposits. A bank run occurs when too many individuals take their money from a financial institution before the long-term debts are returned.