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
There are multiple ways a bank can fail.
Some can be sudden but others may have some warning. Depends on the cause of the failure.
In the case of SVB, most of its assets were long term government bonds. As interest rates went up, those bonds lost value on paper because people would only buy them at a discount. That only matters if they have to sell them; unfortunately for SVB, depositors for scared and started pulling their money, so SVB had to sell the bonds at a loss, which caused more people to pull their deposits, and so on in an escalating cycle.
There are multiple ways a bank can fail.
Some can be sudden but others may have some warning. Depends on the cause of the failure.
In the case of SVB, most of its assets were long term government bonds. As interest rates went up, those bonds lost value on paper because people would only buy them at a discount. That only matters if they have to sell them; unfortunately for SVB, depositors for scared and started pulling their money, so SVB had to sell the bonds at a loss, which caused more people to pull their deposits, and so on in an escalating cycle.
banks aren’t required to have all the cash invested in them available (that’s what “fractional reserve” means, a fraction), they invest the rest and pay a portion of the returns as interest to their clients. svb lost a bunch of money on its investments after the interest rate hikes and inflation of the last year or two, which caused their stock to drop, and then everybody got scared and went to withdraw their money, more money than the bank actually had.
like a lot of things, the signs that things are going wrong can be there for a long time if you know where to look, but the collapse itself happens suddenly.
banks aren’t required to have all the cash invested in them available (that’s what “fractional reserve” means, a fraction), they invest the rest and pay a portion of the returns as interest to their clients. svb lost a bunch of money on its investments after the interest rate hikes and inflation of the last year or two, which caused their stock to drop, and then everybody got scared and went to withdraw their money, more money than the bank actually had.
like a lot of things, the signs that things are going wrong can be there for a long time if you know where to look, but the collapse itself happens suddenly.
Banks collapse, in general, when they don’t have enough money to serve their despositors’ requests. Banks don’t (normally) keep 100% cash deposits on hand…they loan most of it out and keep a fraction around to serve day-to-day operations. If all the depositors try to withdraw all their money at the same time, the bank doesn’t have that much cash. This is called a “bank run”.
In the case of Silicon Valley Bank, which I assume you’re asking about, there was some warning that they were having issues because a *lot* of their cash was tied up in government bonds that had dropped in value, so they kept having to sell bonds at a loss to operate. This, by itself, isn’t a huge deal…it happens all the time.
BUT…a major venture capital firm that had a lot of money in SVB got worried and pulled all their money out, and told all the companies they were invested in, to pull all their money out because they were getting nervous. This *caused* a run, which became a self-fullfilling prophesy and the bank collapsed. If everyone had just sat still it probably would have been fine, but too many people didn’t want to take that chance. When customers stop trusting teh bank, it goes bad *very* quickly. In this case, less than 48 hours.
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.
Banks collapse, in general, when they don’t have enough money to serve their despositors’ requests. Banks don’t (normally) keep 100% cash deposits on hand…they loan most of it out and keep a fraction around to serve day-to-day operations. If all the depositors try to withdraw all their money at the same time, the bank doesn’t have that much cash. This is called a “bank run”.
In the case of Silicon Valley Bank, which I assume you’re asking about, there was some warning that they were having issues because a *lot* of their cash was tied up in government bonds that had dropped in value, so they kept having to sell bonds at a loss to operate. This, by itself, isn’t a huge deal…it happens all the time.
BUT…a major venture capital firm that had a lot of money in SVB got worried and pulled all their money out, and told all the companies they were invested in, to pull all their money out because they were getting nervous. This *caused* a run, which became a self-fullfilling prophesy and the bank collapsed. If everyone had just sat still it probably would have been fine, but too many people didn’t want to take that chance. When customers stop trusting teh bank, it goes bad *very* quickly. In this case, less than 48 hours.
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.
Banks collapse, in general, when they don’t have enough money to serve their despositors’ requests. Banks don’t (normally) keep 100% cash deposits on hand…they loan most of it out and keep a fraction around to serve day-to-day operations. If all the depositors try to withdraw all their money at the same time, the bank doesn’t have that much cash. This is called a “bank run”.
In the case of Silicon Valley Bank, which I assume you’re asking about, there was some warning that they were having issues because a *lot* of their cash was tied up in government bonds that had dropped in value, so they kept having to sell bonds at a loss to operate. This, by itself, isn’t a huge deal…it happens all the time.
BUT…a major venture capital firm that had a lot of money in SVB got worried and pulled all their money out, and told all the companies they were invested in, to pull all their money out because they were getting nervous. This *caused* a run, which became a self-fullfilling prophesy and the bank collapsed. If everyone had just sat still it probably would have been fine, but too many people didn’t want to take that chance. When customers stop trusting teh bank, it goes bad *very* quickly. In this case, less than 48 hours.
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..
Latest Answers