You ask me to hold onto $20 because you don’t have a safe place to keep it. I do. Bob needs to borrow $10. Since I have your $20, I lend him $10 of your $20. Bob agrees to pay me $1 a week in interest, I’ll keep half of that and put half of that into your pile of money.
Normally, this works out well. You have a safe place to keep your money. Bob gets his loan. You and I also get a bit of money in interest from Bob. If you need a couple bucks, you can get it back from me.
But what happens if you want your entire $20 back? Now there’s potentially a problem. I have only $10 on hand. The other $10 is in the form of the loan to Bob. I can’t give you your money. Same thing if Bob can’t pay back the loan – now I only have $10.
That’s a bank failure.
Now Steve comes along and tells you it’s ok; since I’ve been paying him a bit of money for a while, he’ll cover the difference. So you get your entire $20, and he finds someone to take over that $10 loan to Bob. That’s the FDIC.
That’s a very elementary, high level view.
It’s more complex with big banks and while there is a max payout of $250000 per account insured by the FDIC, the FDIC will work to sell accounts, etc to other banks to make sure all depositors get their money.
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