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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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..
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 take money from customers when they deposit into a checking account. The banks lend this same money out as loans or invest it. So banks never have all the “cash” to pay customers. This isn’t usually a problem, but if a lot of customers want to take out a lot of money all at once then the bank may not have enough money available to pay them. We call this a “run on the bank.” Normally this does not happen because it is uncommon to need all your money instantly.
However, If the people who they loaned the money to don’t pay or in the investments loose value, and the customers find out, then customers will want to be the first to take all their money out so they don’t loose any, the bank will run out of “cash” and then the bank may not be able to pay the slower customers when they come to take their money out. That’s what happened with SVB.
Banks take money from customers when they deposit into a checking account. The banks lend this same money out as loans or invest it. So banks never have all the “cash” to pay customers. This isn’t usually a problem, but if a lot of customers want to take out a lot of money all at once then the bank may not have enough money available to pay them. We call this a “run on the bank.” Normally this does not happen because it is uncommon to need all your money instantly.
However, If the people who they loaned the money to don’t pay or in the investments loose value, and the customers find out, then customers will want to be the first to take all their money out so they don’t loose any, the bank will run out of “cash” and then the bank may not be able to pay the slower customers when they come to take their money out. That’s what happened with SVB.
Banks take money from customers when they deposit into a checking account. The banks lend this same money out as loans or invest it. So banks never have all the “cash” to pay customers. This isn’t usually a problem, but if a lot of customers want to take out a lot of money all at once then the bank may not have enough money available to pay them. We call this a “run on the bank.” Normally this does not happen because it is uncommon to need all your money instantly.
However, If the people who they loaned the money to don’t pay or in the investments loose value, and the customers find out, then customers will want to be the first to take all their money out so they don’t loose any, the bank will run out of “cash” and then the bank may not be able to pay the slower customers when they come to take their money out. That’s what happened with SVB.
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.
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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