Why would banks and exchanges need to pause withdrawals if they’re in financial trouble?


Why would banks and exchanges need to pause withdrawals if they’re in financial trouble?

In: 101

Because banks generally don’t hold enough assets to cover all of the deposits, entirely because it’s more lucrative to loan that money out. If too many people try to withdraw their deposits, the bank becomes insolvent and people’s money disappears. The only way to prevent a complete collapse of the bank is to stop people from withdrawing money, but this doesn’t exactly inspire the confidence needed to deposit money in said bank.

In most real banks, the bank deposits are ensured up to a certain amount by the local government, and the banks are forced to keep a certain fraction of their deposits on hand to handle bank runs.

In banks that deal in products not ensured by local governments (i.e. crypto), there are no such rules, so the “banks” can loan out far more than they actually have on hand, because no one’s going to stop them.

But this obviously becomes a problem in the event of a bank run.

Problem often occurs is that customers are requesting more withdrawal than the bank/exchange has in liquid assets: in other words, they don’t have the money to provide to the customers who want it.

If you’re a bank, the worst thing that can happen is someone coming up to the counter asking for their money and you not being able to give it to them. That causes your customers (account holders) to lose all confidence in you, and they will all promptly try to withdraw their money in hopes that they can get some of their money out. This is called a bank run or a run on the bank.

Side note: most if not all privately held accounts at banks are protected by the FDIC, the Federal Deposit Insurance Corporation. The FDIC protects banks and their customers by guaranteeing each account up to $250,000; if you try to withdraw and the bank is unable to pay you, the FDIC will pay out for you instead.

So a bank temporarily stopping withdrawals is a way to get ahead of a bank run. The idea is to buy time while the bank tries to get more funds in (from loan payments or other assets), so that they can reopen later, pay out withdrawals, and not run out of money.

Basically, banks use your money to lend to others to make more money. If you deposit $10,000, and Billy wants to borrow $2,500, I can take that from the money you deposited and lend to Billy and charge him interest. As longs as you don’t come and ask for more than $7,500 before Billy has paid it back, I’m a happy banker. But perhaps Lisa has also deposited $10,000, so even if you do ask for your $10,000 back, I can use $2,500 of what Lisa deposited to make up the difference. As long as I don’t lend too much, and the more customers I have,, the less likely I’m going to be caught out without enough money to cover people’s withdrawals. But if something happens in the economy, and everyone panics, I could be in trouble.

Problems = They don’t have enough money.

Withdrawls = People taking money out of the bank. It makes more problems.

The banks don’t actually have all the money people invested into them. They take your money and loan it out to other people. They only have to keep a small fraction in reserve.

If you’re the first person to withdraw, you get your money. If you’re the last person to withdraw when there’s a run on the bank, you get to hope the federal government will eventually give you your money.