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?
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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.
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.
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.
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.
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.
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.
If their “risky” investment was buying too many long-term gov’t bonds, then shouldn’t we be scared for all of the rest of the banks?
Would this have been averted if the had bought short term bonds or kept more in cash?
If their “risky” investment was buying too many long-term gov’t bonds, then shouldn’t we be scared for all of the rest of the banks?
Would this have been averted if the had bought short term bonds or kept more in cash?
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