ABSTRACT
In the first, the liability holder observes that another bank has suffered a (presumably large) capital loss, from which he estimates that his own bank has suffered a sufficient fall in its net worth to make it worth his while to demand redemption 'just in case' his own bank defaults. A default by one bank may thus lead to increased demands for redemption at other banks, but it does not follow that the other banks face runs that threaten to drive them to default. Bank managements can be expected to be aware of the danger of sudden demands for redemption, and therefore they can be expected to take appropriate measures to protect themselves.4 They would typically do so by holding an adequate capital cushion to reassure depositors (and noteholders, if any) that the bank was still sound. If the stockholders still value the bank, and the stockholders are residual claimants, then the depositors can be reasonably confident that they will suffer no losses because they have prior claim on the bank's resources. The banks can also protect themselves against unanticipated demands for redemption by holding liquid reserves which they can use to meet redemption demands, and by lining up credit facilities on which they can draw if the need arises.
