Final answer:
A bank run occurs when depositors lose confidence in a bank and simultaneously withdraw their funds, leading to the bank's failure. The fear of depositors losing their money is the central issue that causes bank runs and panics. Deposit insurance and the central bank's role as a lender of last resort help mitigate the risk of bank runs.
Step-by-step explanation:
A bank run occurs when depositors lose confidence in a bank and simultaneously withdraw their funds, which can lead to the bank's failure. The central issue that causes bank runs and panics is the fear of depositors that they may lose their money. Even a rumor or perception that a bank may be insolvent can trigger a bank run, as depositors rush to withdraw their funds.
When a bank runs out of cash due to large withdrawals, it intensifies the fears of remaining depositors, potentially leading to more bank runs. This cycle can result in a chain reaction of runs on other banks, creating financial instability in the banking system. In the late 19th and early 20th centuries, bank runs were not typically the original cause of recessions, but they had the potential to make recessions more severe.
Deposit insurance and the role of the central bank as a lender of last resort help mitigate the risk of bank runs. Deposit insurance provides protection to depositors by guaranteeing their deposits up to a certain amount even if a bank fails. The central bank acting as a lender of last resort reinforces the effect of deposit insurance and ensures that banks can access funds when they cannot obtain them from other sources.