How does a modern bank collapse? And is it sudden or is there warning? Seems sudden in the news, but I struggle to understand how a bank can lose billions of dollars suddenly, where does it go?
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I’ll attempt an actual ELI5: you give money to a bank. They store it for you and keep it safe. However, that doesn’t mean that they put it in a box with your name on it. Instead, they keep a record of how much money you (and everyone else) gave them.
So if they don’t put it in a box, what do they do with all the money? Well, one thing they do is to lend out money. So, for example, if you wanted to buy a house, they might let you borrow some money and then you’d pay it back. They also invest money in different things like stocks. These things allow banks to make money from the money that you are storing with them.
This also means that banks don’t have all the money that everyone has ever deposited with them sitting around in cash. This doesn’t mean the money is gone, it means that it’s “not liquid”, which means that it’s tied up in other things like investments.
Usually this is fine, and all banks operate like this. However, if everyone who has deposited money with the bank tried to pull it out on the same day, there would be a big problem because the bank doesn’t have enough cash to cover everything everyone has deposited! If that happens, it’s called a bank run.
So even if the bank did have enough money in theory (counting all assets), if it doesn’t have enough liquid cash to give everyone their deposits back when there’s a bank run then the bank will fail.
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