What does the phrase “banks borrowing short and lending long” mean?
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Imagine you have a piggy bank where you save your money. You can take out your money anytime you want, but you don’t earn any interest on it. Now imagine your friend wants to buy a bike, but he doesn’t have enough money. He asks you to lend him some money for a year and promises to pay you back with some interest.
You decide to lend him some money from your piggy bank, hoping that he will pay you back more than what you gave him. This is like borrowing short because you are using money that is available on short notice (your piggy bank). This is also like lending long because you are giving money that won’t be available to you for a long time (a year).
Now suppose that after six months, you want to buy something with your own money, but you realize that most of it is with your friend who hasn’t paid you back yet. You have a problem because you don’t have enough money for yourself and you can’t get it back from your friend until the end of the year.
This is the risk of borrowing short and lending long: You may not have enough money when you need it because your money is locked up in long-term loans.
Banks do something similar when they take deposits from customers (like your piggy bank) and lend them out to borrowers (like your friend) for longer periods of time. Banks hope to earn more interest from lending than they pay for deposits. But they also face the risk of not having enough money when customers want to withdraw their deposits or when interest rates change.
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