how do banks collapse?

Question

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?

In: 3

Answer 1

It’s actually not that complicated. When you give a bank your money, it doesn’t just put it in a vault or digital vault and let it sit there..

The bank tries to make money on your money by investing it, or lending it out. they can actually lend out more money, than people have deposited with them. Strange but allowed under the laws that govern the United States

The bank is required to maintain a certain minimum amount of will say cash on hand in order to ensure that they can meet any reasonably foreseeable need for people to get their money out And they need to have reserves in case their investments lose money, so that they can still pay depositors back, despite some reasonably foreseeable loss . Presumably, if a lot of people wanted their money out, the bank could liquidate their investments, or sell their loans to another institution in order to have the cash necessary to provide to their depositors.

so that’s all well and good unless..

If people sense that somehow the banks investments have gone south, or that the loans will not be repaired, they might start to withdraw their money .

Other people, seeing some people withdraw their money and lose confidence in the bank, follow suit, and all of a sudden you have what is called a run on the bank, where everybody is asking for their money at once .

The bank cannot meet all of these sudden requests at once because they can’t sell the loans or their investments quickly. They run out of cash falling below, the government mandated minimum amount of cash to have on hand, and then the FDIC shut steps in and shuts them down.

This is what happened in the case of Silicon Valley Bank. They reported a small loss well a relatively small loss on certain treasury bonds, and that was enough to spook depositors, who all started to demand their money. Given time the bank would likely have been able to return everyone’s money however, in the short run, they ran out of cash in the federal government had to step in..