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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The most dangerous thing for a bank is creating a situation where everyone tries to take out all of their money all at once. The technical term for this is a ‘bank run’.
Banks rely on a system called fractional reserve banking, meaning that only a certain amount of cash or liquidity is required to be kept on hand by law. The rest of the money is in turn invested or loaned out to patrons, which is the basis for how banks function and make money (loaning money out to people, organizations, and corporations)
Banks loan out money by design, so by definition there isn’t enough liquidity in a bank to pay off everyone’s accounts because that money is in assets or loaned out to people that can’t be pulled back in quickly. Banks rely on long term investment in said bank to remain functional. This requires that banks maintain credibility and stability.
If word gets out that a bank can’t pay or is having financial trouble, it’s customers might panic and all try to take out their money at once. This results in a bank run and the bank goes bankrupt because they can’t pay.
Major banks are insured by the Federal Government to protect people if this happens, but generally only $250,000 is protected per person. This came about as the result of lots of bank runs happening during the Great Depression.
It’s important to note that Crypto currency has no such protections as Crypto currencies fall outside of traditional banking regulations. So if a Crypto bank fails there is no insurance protection for deposits.
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