A second example of how the liability side of an intermediary’s balance sheet suggests the appropriate form of capital regulation is presented by the familiar problem of deposit runs on banks. Like a policyholder, a depositor has difficulty gauging the health of the financial intermediary.
But unlike a life insurance policyholder, a depositor can withdraw all or most of her funds if she has any fear – even an ill-founded fear – that the bank may be in trouble. Indeed, depositors have a rational incentive to act quickly, since the first to withdraw will have the best chance of getting all their money back.