Final answer:
Bank runs were common during financially stressed periods, such as the Great Recession, due to fears of banks' negative net worth leading to collapses. Deposit insurance, particularly provided by the FDIC, has been effective in preventing bank runs by ensuring depositors' funds. While bank runs are now rare for insured deposits, they could theoretically occur if the insurance limits are exceeded or confidence in the system is lost.
Step-by-step explanation:
Bank runs were fairly common around the time of the Great Recession due to fears of banks' inability to fulfill withdrawal requests if their net worth became negative. This scenario, where a bank's liabilities exceed its assets, potentially originated from loan defaults and other financial pressures. During such events, a panic could ensue, leading depositors to rapidly withdraw funds, thereby depleting the bank's available cash, causing even healthy banks to collapse under the strain.
Deposit insurance, such as that provided by the Federal Deposit Insurance Corporation (FDIC) in the United States, greatly reduces the likelihood of bank runs by guaranteeing depositor funds up to a certain amount, which is $250,000 per account as of now. This provides confidence among depositors, as they know their money is safe even if their bank fails. However, there can be potential drawbacks to deposit insurance, such as creating a moral hazard where banks might engage in riskier behavior, knowing that the deposits are insured. This could lead to higher insurance premiums and possibly a burden on the government if a widespread banking crisis occurs.
While deposit insurance has made bank runs at insured banks virtually obsolete in the United States since its enactment in the 1930s, it is theoretically possible for runs to happen if depositors fear their deposits exceed the insured amounts or if they lose trust in the government's ability to back the insurance program during a severe financial crisis.