That's not really how banking works in a fractional reserve system. The money banks lend to borrowers is created as part of the loan transaction, and in theory the bank retains enough money to pay off all depositors in the event of a bank run.
In theory, they retain enough _assets_ to pay off their creditors, but not enough _cash_. In the event of a bank run they'd have to be handing over their stake in mortgages and other debt that hasn't yet been paid off. But of course these are illiquid, and the creditors wouldn't accept that in general.
In the vocabulary of money supply, you're confusing M0 and M1.
"Illiquid" is just a word for little people as long as the bank is solvent.
I don't think any bank carries lots of cash around these days to pay their depositors. So in case of a run, they have to give them some other kind of money.
Do you mean that they'll always have enough balance with the central bank?
Why do banks care about having deposits?
By money I don't mean actual folding paper currency. These are all just numbers in computers - the central bank buys and sells currency as retail banks need it, but since that would take time most likely during a run they would give you a cashier's check which you could deposit somewhere else.
The amount of actual cash a bank branch has at a branch at any given time is just enough to handle their need for cash. Your typical US suburban retail bank starts the day with something like $20k in the vault. If I wanted to withdraw more than a few thousand bucks in cash I would have to give my bank advance notice.
There isn't actually a piece of currency somewhere for every outstanding dollar (or pound or euro or yen or whatever). If I'm reading this chart correctly there's something like 5 US dollars circulating in the economy for every dollar in currency.
http://www.tradingeconomics.com/united-states/money-supply-m...
The amount of outstanding currency is mostly irrelevant. If I deposit $100k at a bank using an electronic check the bank could turn around and buy $100k in currency from the Fed, but for the most part there isn't any reason to and all they do is change my balance in the computer.
>Why do banks care about having deposits?
Because in theory the amount of money they have in reserve dictates how much they can create in new loans. For example, if the reserve ratio is 9:1 and you deposit $10k, the bank can only loan out $9k on the basis of your deposit.
If too many people withdraw money that quarter the bank has to increase its reserves to match the ratio of outstanding loans by attracting more deposits, selling assets (like loans), or borrowing from other financial institutions (including the central bank).
The reserve ratio is set by the government, and it's one of those knobs central bankers can turn to affect the economy -when they want to stimulate the economy they can increase the reserve ratio, which allows banks to make more loans. If they want to slow things down a bit they can decrease the ratio, which makes it harder for banks to make loans.
This video, while a bit on the melodramatic side, actually explains basic banking reasonably well:
Let me ask you this. Let's say you have a bubble and the economy grows to twice is pre-bubble size. What are people worried about - inflation or deflation? When an economy grows, shouldn't deflation (in this case meaning a drop in price for the same items) be the problem?