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How did a banking panic cause banks to fail during the Great Depression?

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A long line of unemployed men in coats and hats stands outside a soup kitchen in Chicago, with a storefront sign reading Free Soup, Coffee and Doughnuts for the Unemployed. — Great Depression Unemployed men standing in line outside a soup kitchen, Chicago.

During the Great Depression, banking panics caused widespread bank failures because of the fundamental way banks operate. Banks typically hold only a fraction of their total deposits as cash reserves, while the remainder is invested in loans and other assets.12

A banking panic occurs when depositors lose confidence in a bank's solvency and simultaneously demand to withdraw their funds in cash. Because banks cannot immediately convert their long-term loans into cash, they are forced to liquidate assets hastily to meet these demands. This process often leads to a self-fulfilling prophecy: even a previously solvent bank can fail if it cannot meet the sudden, massive surge in withdrawal requests.12

During the Great Depression, these panics were exacerbated by the lack of effective intervention from the Federal Reserve, which failed to act as a lender of last resort to stabilize the system. The resulting wave of failures wiped out approximately 9,000 banks by 1933, severely disrupting lending and contributing to a sharp decline in the money supply and overall economic activity.12