I didn't understand much of the jargon, but if banks don't lend out customer deposits, why are they gone when banks go bankrupt?

If they were not lent out, where did they go?

The bank has a balance sheet of assets and liabilities. When you deposit money, that’s a bank liability. When you take a loan, that’s a bank asset.

If some people don’t pay back their loans, then that loan gets written down, so the bank has fewer assets than before. A certain level of default is expected and baked into their operations.

If many people don’t pay back their loans, the bank no longer as as many assets as it expected. But it still has as many liabilities. The value of the bank will decrease, potentially to nothing.

As the grandparent notes, banks are subject to special requirements in law that define how much capital the bank needs to have to remain solvent. If the bank is no longer solvent then it can’t cover the liabilities (deposits).

In that case either the government will step in to bail the bank out, or the bank will collapse and the depositors will have to be paid from a deposit insurance scheme.

I'm a bit confused here. I understand that depositing money creates a liability for the bank in the sense that money (and interest thereupon) may be withdrawn at any point... but until the depositor withdraws, isn't the actual cash that has been deposited in an account an "asset," in the sense that it is on the bank's books?

US banks have access to the Federal Reserve Bank and get funds from them at the fed funds rate. Then they add some margin and loan it out to you and me. They’re required to keep collateral and can only lend some smaller percentage of their capital. Etc etc.

Such is what I have pieced together.

That doesn't answer where deposits go in a bank run.

I agree, and IDK why it is so hard to talk clearly about finance. Here is how I understand what's been said (not an expert):

When a bank pays a loan out to its lender, it must have capital (valuable assets actually owned by the bank) to back it up. But these "assets" are not always easy or possible to liquidate, or turn into cash. This is where the other person's deposit comes it. They use the deposits for "cash" instead of liquidating the assets they own in order to pay out the loan. This is what is meant by providing liquidity.

Technically, the bank's own assets can be considered to be backing the loan, but the long-and-short of it is that YES, bank's do use the cash from their deposits to make loans, and that is why there is no money available when the bank run happens.

Disclaimer: this is my interpretation of what others on this thread are saying. I don't actually know if this is right or wrong

> and IDK why it is so hard to talk clearly about finance

Because unlike in engineering, in finance, conservation of "energy"/"money" allows arbitrary creation of negative money to cancel out arbitrary created positive money.

We pretend money is a real thing you can have, but it's actually more like one of the two opposite poles of magnet.

It's a game with made up rules, not a natural consistent system.

You deposit $100 dollars at two banks, the banks lend to each other until they have created 10x as much bank money than they have cash. The cash didn't go anywhere, it is still there but if the bank were to pay it out it would not meet its regulatory requirements and be shut down even though it might have $1000 worth of assets if you give it enough time.

The problem essentially is that the money can be withdrawn all at the same time but the obligations cannot.

You deposit $10k in the bank

The bank originates a mortgage to someone. It uses (some of) your $10k to give cash to the customer getting the mortgage, and the customer then uses that cash to buy the house.

For whatever reason, a bank run happens, i.e. everyone comes to make a withdrawal all at once

You try to withdraw your $10,000. The problem is that everyone wants cash, not shares of houses, but the bank only has so much cash.

The bank is good for your $10k, but not on the timeframe you want it. The bank is _illiquid_, but _insolvent_.

The bank will try and sell it's mortgages to someone else for the money, but if it tries to do this all at once it will likely end up selling them at prices that are below par. In that case the bank might end up with less assets than liabilities; this makes the bank _insolvent_.

In a deposit insurance scheme, the government takes over the bank, pays out to customers, and services the loans. The government can do this because it can easily create liquidity. Generally in recent history the government still makes a profit when it reduces an illiquid bank

Illiquid but solvent

I don't think that's quite right as when a bank loans out money it creates the money, and when the loan is repaid the money is destroyed.

https://www.bankofengland.co.uk/knowledgebank/how-is-money-c...

No, while they can borrow reserves from the central bank (Federal Reserve if you're in the US), they can't 'lend those reserves out'. Those reserves are mostly useful for liquidity. The way that the reserve rate affects mortgage rates is more complicated.

The issue is that it's very abstract, and all the mechanics of banking are accounting operations, whereas people don't tend to think that way. The deposits themselves are entries on the liability side of the bank's balance sheet. The bank doesn't store money for customers, they take whatever asset you give them and give you basically an IOU in return. So the "customer deposit" is not what you gave the bank (say if you deposited cash), it's a number in a database. Just like what is 'in' the bank's exchange settlement accounts at the central bank (e.g. Federal Reserve), and just like what is moved around in international finance. Electronic messages representing IOUs.

This is balanced by a mix of assets, which are a whole number of things. A tiny amount of cash, a small amount of central bank reserves, some in treasuries and bonds, and the assets created by the bank loans, etc.. (When the bank creates those loans, they create new deposits and a new asset in the loan, in equal amounts. So the assets and liabilities of the bank increase but the balance is zero).

So if the bank gets in trouble, it's because some of the asset mix has declined in value (like too many people have defaulted on their loans) to the point that the assets no longer cover those liabilities.

I think the answer to my question from this is that the money in my Citibank account is part of all the other money Citibank can lend out.

There is no specific pile anywhere that is "my money", but if I withdraw $10k, the bank has $10k less to lend out.

No, the amount they can lend out is mostly based on their capital. If they want to lend money out but they have reached their capital adequacy limit, they have to capital raise by issuing new shares for cash, not seek more deposits. (I’ve been a bank shareholder when they had to do this, when the Basel III rules changed the limits to make things more stable).

Deposits are liquidity that help grease the wheels, so it’s necessary, but it’s actually more the transfers of money moving in and out that they need, not liabilities sitting on their balance sheets.

Why do banks bother with customer deposits at all, instead of spinning out to separate companies?

I have seen a type of banking proposal where the bank always borrows from the central bank at x% and issues loans that way and just passes the x% cost to anyone holding the money. That means no deposits were required to begin with. If anything, cash means that the person who withdrew money would be stuck with the borrowing fee until they deposit their cash back in.

So yeah although this is still theoretical, it is indeed possible to do banking without having a single customer cash deposit.

In that proposal, it seems like all the risk of the loan is carried by the bank with none of the profit. How would such a bank be profitable? What happens if the loan is not paid back?

Parent meant x%+y% or some other scheme for risk management and profit.

Well, bank lending creates deposits, so they need to deal with deposits to actually be a bank.

There are non-bank lenders (and non-bank payment services companies that offer prepaid visa/mastercard products), but they ultimately are then customers of the bank and they are much more limited in what they can do that banks are. That's why it's crazy difficult to get a banking license.

You’re creating a lot of confusion by ignoring cash accounting (the physical dollar I give a bank is then given to a homeowner as a mortgage) and talking about GAAP accounting, without making it clear that is what you are doing (the jargon only makes things worse).

Like sure, it’s loan to capital ratio that matters but as you point out:

> Bank runs are a liquidity problem because the bank's assets aren't all liquid enough to transfer out all the deposits the bank holds,

This is because in practice the money you give to a bank is lent out, even if it’s technically leverage against capital.

Banks cannot and do not lend out deposits. Bank deposits are a liability of the bank, they do not have it in the first place to lend out. When the bank gives someone else a $500,000 mortgage, they just create the money out of nothing and increase the customer’s bank balance. This new $500,000 liability is balanced by the new loan asset. Almost all money is of this type rather than physical currency.

Ok so then by your logic, why do banks care about collecting deposits?

Because they need a liability to offset their assets? Ok wildly backwards but sure.

And wait, in your metaphor, where does the $500k asset of cash that a depositor gives a bank (which offsets that liability) go? It’s just fake in your mind?

Some banks care about collecting deposits because the interest they earn on short term paper is more than the interest they pay on deposits. Some banks don't accept deposits at all -- these are called investment banks.

Also, banks don't really do a lot of maturity transformation -- there are so many myths about how banks operate -- if you look at a bank's balance sheet, you will see a range of short, medium, and long term debt that is constructed to roughly match their short, medium, and long term assets.

Rather, banks make money off of spreads, because banks have lower funding costs than their customers, due to a web of in house expertise, government guarantees, access to special lending facilities and payment networks that others can't access.

If you want to really understand banks, you should stop talking about deposits, which aren't particularly important, and instead focus on mortgages, which dominate the entire financial industry. If you want to buy a house, you could try to sell a bond into the bond market. But a household will have a hard time selling a bond. So they go to a bank, which performs its own credit analysis and then gives you a loan while they sell a bond. The interest you pay to the bank is more than the interest the bank pays on the bond. Banks make money off of this spread, which is small, but it is leveraged, so the total return on capital for the bank is high.

If you don't like it, you are welcome to try to sell your own bonds for a lower rate than what the market charges the bank. Doing that will be an educational exercise that will explain how banks make money, and it has nothing to do with funny business about deposits.

Most banks basically just break even on the deposits, given the costs of owning all those branches, paying the tellers, etc. Even if they make a profit, it's a small profit, but it's a great way to upsell other financial services (mortgages, auto loans, lines of credit) that make money for the bank, as well as charging fees, etc. They certainly don't need your deposit in order lend someone else money, because they borrow from the capital markets at one rate, and lend at a higher rate.

>Some banks care about collecting deposits because the interest they earn on short term paper is more than the interest they pay on deposits. Some banks don't accept deposits at all -- these are called investment banks.

LMFAO. I want to go to Goldman Sachs's Balance sheet and then tell me how much they have in deposits ($394 billion!!!). I want you to go to Morgan Stanley's and tell me the same ($338 billion!!!). Nearly all banks use deposits as an easy source of capital that they then invest/lend out.

You are confusing retail deposits with deposits.

Like sure, there's boutiques like Qatalyst and Allen that limit their deposit base for one reason or another, but they are marginal in scale vs. real investment banks.

>If you want to really understand banks, you should stop talking about deposits, which aren't particularly important, and instead focus on mortgages, which dominate the entire financial industry.

This is such a wild conversation! I am talking about mortgages, which are funded by deposits!

>But they don't need your deposit in order lend someone else money, because they borrow from the capital markets at one rate, and lend at a higher rate, and this has nothing to do with borrowing short term and lending long term. Rather, the primary risk for banks comes from leverage.

Yes we agree! And one form of extremely cheap borrowing is taking deposits! That's why they pay interest on it! It's borrowing! It's a liability on the balance sheet! How is this not clicking for you?!?!?!

That’s a good a question, understanding why banks want deposits was hard for me to understand in this model. My current understanding is that taking deposits is a cheap source of funding for the bank. They could borrow required reserves from elsewhere but it’s cheaper to take it from customers who accept low interest rates.

For the second part, I agree that if you bring $500k cash to your bank and deposit it, then that asset is real and it basically goes into the bank vault. But that is not the typical case. Most deposits do not come from putting cash in the bank (after all, the amount of cash/central bank reserves is much smaller than the amount of bank deposits). Most of them are just an IOU from the bank and we use these IOUs as the most frequent form of money.

>My current understanding is that taking deposits is a cheap source of funding for the bank. They could borrow required reserves from elsewhere but it’s cheaper to take it from customers who accept low interest rates.

Yeah, why it's confusing to you is that you're segregating "borrowing from capital markets" from "borrowing from depositors" when they are effectively the same thing (both are interest-bearing liabilities).

>For the second part, I agree that if you bring $500k cash to your bank and deposit it, then that asset is real and it basically goes into the bank vault.

I suggest you google 'fractional reserves,' because no, the money does not go into a bank vault (though some of it does!).

> Most of them are just an IOU from the bank and we use these IOUs as the most frequent form of money.

The logical fallacy here is that you're seeing how many IOUs there are (many) and how many cash dollars there are (much fewer!) and then assume that IOUs don't have to be attached to a physical dollar but they do (keep in mind, a physical dollar could just be a line item on The Treasury's balance sheet, it doesn't have to be paper) It's just that many IOUs can be attached to the same dollar through the credit multiplier.

But there aren't dollars given to banks mostly. Cash is a tiny fraction of the money banks handle. Most of the payment volume is millions of electronics messages between banks to debit and credit numbers in people's accounts, and only at certain times of the day the net of that (a far, far smaller amount of reserves) are actually moved.

It's actually the other way around - trying to follow a physical dollar just makes you confused, because all the actual business of the bank is happening in accounting-land (the bank's balance sheets and electronic records of customer accounts).

You are splitting hairs where it doesn't matter. More alarmingly, by your reasoning the bank is not lending out cash either, so there is no value in considering 'cashflow' at all.

But in practice when people say they 'pay cash' for something large like a house or a car, they are usually effecting a bank transfer (well, in Korea at least). I understand that under the hood in the US this is an IOU between banks, but to the depositor there is no difference whether the money is cash or bits. What matters is whether the bank has the liquidity to provide upon request.

Then by your logic, shouldn’t banks not want customer deposits? Isn’t it just burdensome overhead?

Trust me, I get that people aren’t Fedexing cash envelopes between banks, but that doesn’t mean money is fake and banks can invent it out of think air (they can only multiply it)

And to be clear, again, you can very easily follow physical dollars at banks (otherwise imagine the fraud that could happen!), it’s just circular so multipliers get applied.

Like I get it’s complicated, but my deposit goes into a mortgage that then goes into another account, etc etc etc. that’s called the “credit multiplier” and we can definitely track it.

Yes an no. When there was no electronic means of transactions, what banks lent out was indeed mostly customers' deposit plus their own assets.

Things became interesting when electronic transactions came into play. Banks virtually no longer have to payout any cash when they issue a loan to a client as they now only need to change two numbers: credit their asset account, and debit loan customer's cash account. So unless there were transactions paying out to another bank, there were no cash movements. So the minimum cash the bank should keep in their operation accounts is just the difference of the transactions paying out and those receiving in.

But does that mean customers' deposits are not significant to the banks? Nope. Banks actually lend out much more than their customers' deposits. How much can they lend out is basicly the deposit amount divided by the reserve rate, e.g. 20%.

Bank runs are a problem in the sense that the bank has a short term liability but they have long term assets. This is called a maturity transformation.

If a bank does a transfer to another bank it will have to send its reserves which means it might have to borrow reserves from another bank or sell its long term assets to get enough reserves and that long term asset might worth a lot or worth very little depending on the difference between it's locked in interest rate and the current interest rate.

This is why banks sell their treasuries to the Fed, they have a long duration asset and a short term liability, so they give it to the Fed to get a short term asset.

I don't know what SBF is doing but maturity transformation is probably the riskiest thing you can do as a bank and it is very likely to break down eventually unless you have a central bank that spreads around the risk. From a purists perspective banks should only use certificates of deposits to ensure that their liability duration is longer than their asset duration. Of course that is difficult in practice because nobody is buying CDs nowadays.

The difference between a bank run on the licensed banking system and a crypto exchange is that the licensed banking system has a lot of experience with these types of problems meanwhile in the cryptospace you ask your neighbor and hope he doesn't shrug.

>nothing to do with the amount of deposits

  "Assets = Liabilities + Equity" <-- should "L" be in here or not?

The ratio of assets to capital is limited to prevent levering up to infinity, ok.

But if the liabilities are mostly deposits, then it's the deposits that allow it to be a levered business at all.

This is all a roundabout way of saying that, yes, they do lend out the deposits.

Let's imagine a simple bank where my company is the sole depositor - it deposits 100k dollars. Let's assume the bank has no other assets or liabilities - its only asset is the 100k dollars I deposited, and its only liability is the 100,000 dollars it has to pay back to me.

Alice comes in and asks for a 50k dollar loan. The bank accepts the loan, and now has another asset - the 50k dollars that Alice owes them, and a new 50k dollars liability - the deposit with Alice's money. Alice than buys an antique one of a kind Russian doll with her 50k dollars from Bob, and the bank transfers this liability to Bob's bank. Alice fails to pay back her loan, and the bank becomes the owner of the antique one of a kind Russian doll worth 50k dollars.

However, someone finds a new trove of similar dolls, and this ones becomes essentially worthless. So, now the bank's assets are in total only 50k dollars, but its liabilities are still the 100k it owes me. If I try to buy another of Bob's dolls for 80k dollars, the bank must find someone willing to lend it 30k dollars, or it can't honor the transaction, even though I had deposited 100k dollars with them: they lent out my deposit.

Of course, in practice, when Alice asked to transfer her funds to Bob's bank, the bank would have not immediately used my deposit, it would have sought to obtain credit from someone else, using some of the 150k dollars in assets it had at the time as collateral. But, if it couldn't obtain such a loan fast enough, it would have indeed used money from the deposit it had.