In the 1930s, when there was a run on a bank, customers would line up for blocks to withdraw their funds. Today, bank runs are different and regulators are still learning how to handle them.
However, the rescue of Continental Illinois National Bank and Trust Company last week has reassured the financial community of the ability of the government to save even a major troubled institution.
''It seems very clear that the government has a great deal of power to keep the financial system from falling apart,'' said Samuel Chase, of Chase, Brown, and Blaxall Inc., a Washington, D.C., consulting firm in the banking area.
Mr. Chase figures the rescue operation has brought some reassurance to the financial world that the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), and the Comptroller of the Currency - the three bank regulatory agencies - in consultation with the Treasury also could manage a banking crisis resulting from the default of a major debtor country, such as Argentina.
''Investors are less skittish,'' he says.
Just as in the banking debacles of the 1930s or earlier, a run on a bank today results from a sudden weakening of confidence by depositors. They fear for the security of their money. Bank runs are much less common today because Congress, learning from the experience of the 1930s, set up the FDIC to insure bank deposits. Most depositors were assured of getting their money back, even if their bank completely failed.
FDIC insurance, though, does not cover larger deposits - those above $100,000 . It was those deposits that fled Continental when rumors of the bank's insolvency - false at the time and probably technically still so - spread rapidly.
These large depositors are mostly institutional - mutual funds, other banks (interbank deposits), insurance companies, corporations, and so on. Often the money is short term, perhaps even overnight. Such depositors do not line up in front of cashiers' windows - they wire the bank, directly or indirectly, to place their money elsewhere. Or, in the case of Certificates of Deposit, they do not renew them when they expire.
Banking experts are now pondering what can be done to prevent other runs, like the Continental one, from upsetting the financial system.
Andrew Brimmer, a former governor of the Federal Reserve System, and now an economic consultant in Washington, figures that FDIC chairman William M. Isaac made a ''serious mistake'' in signaling earlier that the FDIC would not protect depositors beyond $100,000 in the case of merging an insolvent bank with a stronger institution.
''It set up expectations that if a bank got into trouble, and even was merged successfully, there would be losers,'' Mr. Brimmer said. Indeed, in a few recent cases of small banks getting into trouble, they were bought by stronger banks with the larger depositors getting only a portion of their money back.
To save Continental, Mr. Isaac had to promise that no depositor - big or small - would lose any money. ''The FDIC had to backtrack,'' Mr. Brimmer noted.
The original purpose of the FDIC in warning large depositors that they would not necessarily be covered in the event of a bank getting into difficulty was to introduce more of the risk of a free market into lending money to a bank (making a deposit). In this way, depositors would be more careful to see that a bank was sound, and bank management would have an extra incentive not to take excessive risks in using the money for loans or other investments.
Brimmer says ''it is improper to single out large depositors and try to use them to impose discipline on bank management. That policy should be abandoned.''
Rather, he says, stockholders and bank management should pay the penalty for bad loans or other mistakes. (Continental has some $2.3 billion in ''nonperforming'' loans - those not current on interest payments. This works out to a high proportion of its assets by banking industry standards.)
Others disagree. For instance, Edward J. Kane, a professor of economics and finance at Ohio State University, Columbus, would instead alter the FDIC bank-deposit system to take regard of the varying riskiness of commercial banks. At the moment, all FDIC banks pay an insurance premium of 1/12th of 1 percent per year on deposits under $100,000. Mr. Kane suggests that this premium vary according to the riskiness of the bank's assets and deposits.
He also would trim FDIC insurance to, say, $10,000, with depositors free to obtain insurance for sums above that from nongovernmental insurance companies.
For private insurers to properly assess the stability of a particular bank, however, they would need more information. So, Professor Kane proposes, banks should be required to divulge more information and adopt new accounting rules that value assets at their market value rather than book value. (Market value is what a free market would pay for such assets as bonds or loans. Book value is what the bank actually paid out for that asset.)
Another possible lesson from the Continental case, according to several experts, is the need for Illinois to loosen its banking regulations. At the moment, Illinois banks are limited to three deposit-taking operations within a very limited area. Since interstate banking is also against federal law, in order to expand, Illinois banks have had to branch in foreign countries or ''buy'' money from other institutions (such as other banks) to relend at a rate that should offer a profit.
As a result, Continental, more than most banks, was doing business with ''bought'' money and thus was more subject to a run than if it had many branches with more stable small depositors.
The House Banking Committee plans hearings on the Continental case. It is expected to deal with some of these reform issues.