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Comment by BurningFrog | Hacker News Reader

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?

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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.

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.

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