How do banks fail and what happens next?


Hey everyone. Been seeing a lot of articles about Silicon Valley Bank failing. Says it was the first big bank since 2008 to do so.

How does this happen, what does this mean, what happens next?

In: 273

Banks don’t just store the money that people deposit. Depending on the bank, they loan it out to others (mortgages, car loans) and/or invest it and make profits off the interest and investment growth. They keep a relatively small amount of deposited cash as a reserve to cover withdrawal requests.

Sometimes (hopefully very rarely) something causes a crisis of confidence for a bank’s customers and a whole bunch of them try to withdraw their money at the same time, exhausting the bank’s reserve. This is called “a run on the bank.” When a bank can’t meet its customer withdrawal obligations, it fails. (Watch the movie: “It’s a Wonderful Life”)

In the US the FDIC insures bank accounts up to $250k each so customers will eventually get at least some of their funds back.


This bank targets starts up. They have looser “riskier” profiles they will lend to and offer high returns for accounts.

They were heavily invested in long term bonds.

When the govt started raising bonds, existing bonds become less appealing because they had lower rates. This is important.

When the govt raises the price to borrow, lending slows. Starts-ups….start up less because it expensive. Investment slow, banks taking in less money (assets.)

Now at the same time, the banks clients are feeling the same pressure so they withdraw money from the bank.

The bank now has to sell the bonds it bought at a discount, essentially taking a less to pay back it’s clients.

Multiply this out and suddenly the bank fails because it can’t repay everyone who is asking for their money because they’ve lost money.

Think of this way – pretend 10 people gave you 1000 dollars each a year ago. You put $9000 in the stock market and hold on to $1000.

The S&P has dropped ~8% in the last year so your investment is currently worth $8280

All 10 people ask for their money back.

You cover the first person with cash on hand ($1000)

You cover 8 other people ($8000)

You can only give $280 to the last person.

You now have no money or investment (assets) and you still owe $720.

Youre bankrupt (failed.)

Now the govt comes and steps in (in reality before you’ve sold all your investments) and takes your assets or has a healthy bank takeover. They pay the customers the federally protected amount $250k with any remaining money + govt money. If you were owed more than that you get certificate saying you’ll get the rest if possible, but without certainty and not from the govt purse.

The most well-known reason for bank disappointment happens when the worth of the bank’s resources tumbles to underneath the market worth of the bank’s liabilities, which are the bank’s commitments to leasers and investors. This could happen on the grounds that the bank loses a lot on its speculations.

To answer your question, you first have to understand how banks make money.

People need a safe place to stash their money. Other people need someone to borrow money from, whether it’s to start a business, go to school, buy a house, or otherwise.

Banks take deposits from the first group. Then they turn around and loan that same money to the second group. The second group pays the bank a fee for borrowing the money. The bank pays a smaller fee to the people who made the deposit, and pockets the difference.

However, there’s an illusion here. The first guy thinks his money is safely at the bank, but it’s not. It’s been loaned out to the next guy. So what happens when the first guy goes to the bank and asks for his money back?

Well, chances are, enough other people have *also* deposited money that the bank can pay the first guy back. As long as the bank keeps a smaller pool of deposited money on hand, and doesn’t loan ALL of it out, the bank can cover a typical amount of people withdrawing.

But what happens if *everyone* decides to withdraw their money at once? Well, that money doesn’t exist at the bank anymore. It was loaned out to other people. Those people don’t have it anymore either! It was used to pay tuition, or a home seller, or a car dealership.

So… poof. The money people thought was safely deposited at the bank cannot be repaid to them. The bank goes out of business, and the federal government swoops in to pay all the depositors back with taxpayer money, but only up to a certain amount.

Ironically, it is often the fear of this happening that causes everyone to try and pull their money out at once in the first place, before everyone else can. The fear of a bank run is what causes the bank run, which is how banks like SVB can implode in under 24 hours.