Why would banks and exchanges need to pause withdrawals if they’re in financial trouble?
In: 101
Most of these comments are correct, but to point out:
Banks can get an “overnight” loan from the Federal Reserve to cover themselves if there are too many withdrawals at once. So not only does the FDIC help, low-level miscalculations as to withdrawal rates can easily be met.
There’s plenty of stopgaps on the way to a bank run, which is why they basically don’t happen anymore. If a bank is instituting pause withdrawals, it’s because something truly terrifying has happened, either with that one bank (gross mismanagement to the point that the gov’t isn’t helping as it should) or something systemic (…2009).
[removed]
When you deposit money into a bank account, the bank doesn’t just throw it into a vault. They loan it out to other people. They keep some of it, so people can withdraw some of their money, but most of it is paid out in loans to others.
When a large amount of those loans default, the bank might not be able to get enough money to pay out their customers, and they’ll pause withdrawals until they can borrow enough money (or call in enough overdue loans) to cover what people want to take out.
The only real alternative would be to allow people to withdraw money until the bank literally ran out of cash, and that would be a really bad situation. They couldn’t pay their employees, and it would be really hard for them to borrow money or even stay in business.
Banks don’t have that issue in todays world unless the country’s finances are in terrible shape.
While in the US the FDIC insures bank deposits, there is no such structure for deposits in an exchange such as cryptocurrency firms.
Crypto exchanges perform similar lending functions as commercial banks, but do so without a typical solid financial basis – the collateral for a bank loan is often real property or stable assets. Crypto loans use their own tokens or some version of the coin as collateral with no insurance for liquidity issues or regulatory recourse for loss.
Crypto exchanges that limit withdrawals are over leveraged, having loaned out more money than they could repay. A pause could help them regroup temporarily to prevent all the assets being withdrawn and postpone the collapse of the firm.
When you deposit money in a bank, the bank does not simply hold those funds for you. They will lend “your” money to other people (and businesses). They keep enough cash on hand to be able to cover most withdrawals, but if EVERYONE wanted their money all at once, they don’t have enough cash to give it all back. This is what is known as a “bank run”, and when it happens, often the bank in question will become insolvent and disappear…along with the savings of everyone who had money deposited.
In the US, the FDIC insures deposits up to $100,000. So if this happened to you or me, we could (in theory) still get our money, as long as the Federal Government is willing and able to cover the losses. In other countries, like China, there is no such mechanism or protection, and customers who get stiffed by the banks are just out of luck. (which is why there are massive protests in China right now!)
To understand this, you have to understand *fractional reserve banking*.
When you deposit money at the bank, they don’t just keep it. They invest it. Specifically, by loaning it out to other bank customers as home mortgages, business loans, lines of credit, etc. Those people who borrow the money pay the bank interest. That’s how they make money. The bank then keeps some fraction of their total deposits on hand in cash, so when people want to withdraw their money or close their accounts they can do so. Thus, *fractional reserve*- a fraction of the money is kept in reserve, the rest is invested.
This generally works quite well.
There’s two things that can go wrong though.
The first is if a lot of people want to take all their money out at once. The first handful will get money, but once that reserve is gone, the bank has no more money to give out. It can borrow from other banks or from the government, but that costs the bank money because then *they* are paying interest.
The second and much bigger problem is if a lot of the people who borrowed the money default on their loans- that means they can’t pay them back. The banks knows a few will default and plans for it. But if a lot of people do, then suddenly much that money that’s supposedly invested and earning interest is actually just *gone*. Once again, the bank can borrow money to pay to people who withdraw, but the bank is then paying interest, and it’s not making money.
—–
So the answer to the question– if a lot of the places where they invested your money are defaulting, or a lot of people are withdrawing at once, or both, they may pause withdrawals until they actually have the money to give those withdrawals.
Latest Answers