I’m not claiming to be clever. But that’s the overall picture. Many banks have placed themselves at risk, because they’ve reduced what they hold to well below previous levels that were considered safe.
To survive, they have to have enough on hand to conduct business for people making withdrawals. I’m not denying lending or investing, but people also take money out.
Fractional reserve banking has been a practice, yes. The Rothschilds invented it. You still need a certain amount in the bank to cover withdrawals. It’s still a problem if too many people try to take out their lifesavings, as it’s already been noted.
The Bank Run scene - It’s a Wonderful Life
I don't know if that's true at all. I'd be curious to see if you have any information to support that statement.
Banks are among the most heavily regulated companies in the world. The reserve requirements for a bank are established by the FDIC and/or Federal Reserve, not just pulled out of thin air haphazardly.
Interestingly, banking is one of the only industries in the U.S. today where the laws and regulations are set up so that the business establishment (the bank) is actually screwed on behalf of the customer (you and me).
1. Start-up Company ABC deposits $100 million in Bank XYZ over the course of several years from 2015-2020. Most of this money is investment capital from the founding partners.
2. Bank XYZ pays out 2% to Company ABC on these deposits during the low-interest environment of that time.
3. The bank takes the $100 million and uses it for both lending activity and reserves. $50 million is used to make loans that pay 5% to the bank. $50 million is invested in long-term U.S. Treasury bills paying 3%. The "spread" between the bank's investments (5% on the loans and 3% on the government bonds) is how the bank pays its bills and makes money.
4. In 2023, Company ABC comes to the bank and says: "We need $20 million to fund a merger/acquisition."
5. Bank XYZ doesn't have $20 million in cash lying around because it has committed the $100 million elsewhere. So it basically has two options: (A) borrow money from another bank through a 30-day, 90-day, or six-month "interbank" loan; or (B) sell off some of its U.S. Treasury bills to raise the $20 million.
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Note that everything I've presented here is exactly how the banking industry has worked for decades. There's nothing unusual about any of this. You'll also note that one option the bank does NOT have is to tap the $50 million it has used to make the loans paying 5%. If you have a 30-year mortgage on your house, the bank can't make you pay it off immediately just because the bank needs the money to meet its obligations to its depositors.
This process fell apart in the last 2-3 years for two basic reasons that relate to the process I described above (and not that neither reason has anything to do with defaults on the bank's $50 million in loans, "risky investments," or anything of that sort) ...
A. Interest rates rose so rapidly from 2021-2024 that when Bank XYZ goes out looking to secure its short-term interbank loan, the rate they have to pay on that loan is 7% or 8% -- which is higher than what the bank is getting on its 5% loans and its 3% Treasury bills. The bank has to run at a loss just to finance manage its cash flow this way.
B. With interest rates rising, existing U.S. Treasury bills paying 3% to their holders lose a lot of value. Who wants to buy an existing U.S. Treasury bill paying 3% when the U.S. Treasury is issuing new debt paying 5%? So the bank's $50 million in Treasury bills aren't worth $50 million right now, and the bank may have to sell about $30 million of those bonds to generate enough cash to fulfill the $20 million of Company ABC's deposits. The bank loses $10 million in its bond portfolio just to make good on a $20 million deposit obligation.
*** Now imagine this happens 100 more times with other corporate customers. ***
This -- and not insufficient bank reserves -- is what has been driving the turmoil in the banking industry since 2022.