I don't understand fully how banks go under. Especially understanding how they work.
If a bank has $1,000,000 to loan and you borrow $100,000 then common sense would dictate that the bank now has $900,000 to loan. Well... this is not the case due to fractional reserve banking and due to the way the bank views your loan.
The first thing to understand is that when you sign a loan you do not reduce the amount of money they have to loan. You increase it. You signature is viewed as more money they have on their books because you have just agreed to speak for $100,000.
So... since they only have to have a fraction of the money on hand (let's say 10%)... you have just signed for $100,000 so they can now loan out an additional $90,000 because of your loan. You did not borrow money as much as you created money and they charged you for doing it.
When they loan out the $90,000 to someone else... excuse me... when the next person creates $90,000 made possible from your loan then can now loan out an additional $81,000 and that cycle goes on until every loan creates an ability to loan 9 times the amount of the loan... So... they had $1,000,000 to loan. They loaned you $100,000. When the full potential of your loan is realized they will have then had a potential $1,900,000 to loan because you "borrowed" $100,000 at a time that they had $1,000,000 available.
So... that basic concept understood.
How does a bank go under?
The only thing I can figure is that the downside of the way they figure banking is that when loans go default the impact is exponential. Not sure though.
The numbers you used are somewhat reversed. They loan out more than they have on deposit because they are only required to have a reserve ( a fraction the deposits on hand).
Banks make bad loans. When they are not repaid, they lose money.
Banks make investments. When they invest in the wrong thing they lose money.
The numbers you used are somewhat reversed. They loan out more than they have on deposit because they are only required to have a reserve ( a fraction the deposits on hand).
Banks make bad loans. When they are not repaid, they lose money.
Banks make investments. When they invest in the wrong thing they lose money.
Oversimplified but that's the basics
But loans are accounted as a credit rather than a debit in the crazy upside down world of banking.
There are a number of reasons, but probably the single biggest is called the Community Reinvestment Act. You will see this hanging on the wall of any bank you walk into.
Layman terms: It requires a % of all bank lending to be done to risky customers and/or risky neighborhoods.
There are a number of reasons, but probably the single biggest is called the Community Reinvestment Act. You will see this hanging on the wall of any bank you walk into.
Layman terms: It requires a % of all bank lending to be done to risky customers and/or risky neighborhoods.
Indeed... and I have seen banks who did not participate as they should and are still solid in this shaky economic time and what are they getting right now?
The way I understand it is that the banks were forced to lend money to people who were high risk. The initial mortgages were then packaged and resold numerous times until no one really understood what they were investing in. The banks thought they were investing in very safe assets which were backed by real estate values until real estate values started to fall due to foreclosures and bad lending practices. Then the banks probably started calling high risk loans which caused real estate values to fall even more and it was just a snowball effect.
I have also heard that the accounting rules have changed and this causes banks to take losses on their books that they might never realize. Say that you have an asset, a $150,000 house that is backing a loan and that house is now valued at $100,000 the bank is forced to record a loss even though they might end up selling the house for $125,000. So the new accounting rules are ultra conservative and might not end up showing a true picture of the financial condition of the bank.
Regional banks, like Simmons Bank, here in Arkansas, have had almost no problems because they don't keep longterm mortgages on the books but resell them and additionally have been very conservative in their loan practices.
It all comes down to folks getting a little greedy and taking to much risk in order to benefit from short term gains.
most of the regional banks in the midwest, my state in particuliar are still strong because they keep there loans and dont farm them out , package and sell them, they also dont relax there standards for home loans, banks go under fast when they get over extended, lose money, and become undercaptialized, thus the tarp money that saved the banks, or put them under govt control, just the facts man, dt
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