Final answer:
A loss of confidence in the banking system that results in a run on banks is called a banking crisis. This situation arises when depositors collectively withdraw their savings due to fears of the bank's insolvency. To mitigate such events, banking regulations and deposit insurance systems have been established to protect depositors.
Step-by-step explanation:
A loss of confidence in the banking system that leads to a run on banks is called a banking crisis. A bank run occurs when depositors race to withdraw their funds from a financial institution out of fear that the bank will become insolvent.
During a bank run, the demand for cash exceeds the bank's available reserves since banks operate on a fractional reserve basis and lend out most of their deposits. This can quickly lead to a shortage of liquid assets, causing even healthy banks to fail if they are unable to meet the sudden demand for withdrawals. Historically, bank runs have not been the initial cause of economic downturns but have been known to exacerbate existing recessions by reducing market confidence and triggering a cascade of failures within the financial system.
Modern banking regulations and systems, like deposit insurance, have been put in place to protect depositors and prevent such crises from occurring. This system guarantees that even if a bank's net worth becomes negative, the insured deposits remain secure, thus reducing the likelihood of bank runs and maintaining stability in the banking sector.