Collapsing banks, what’s the problem?
16th September 2008
An excellent question, backed by a very common-sensical analysis.
The starting point must be to investigate why this bank went under. That is fairly simple, it had obligations to pay money but no money with which to pay them. Although it is dressed up as a mysterious business comprehensible only to the brilliant, investment banking is pretty straight forward. Customers hand over a lump of cash and and the bank invests it hither and yon in the hope that a profit will ensue. The customer receives some of the profit and the bank receives its cut. Everyone is happy and the world continues to turn. Of course they won’t attract many customers by saying “hand over cash and we’ll try to make it grow”, so they offer incentives such as a minimum rate of return over a given period. The customer must leave his money with them for a minimum time. At the end of that period the banks must not only make sufficient profit to be able to pay the customer his guaranteed interest they also have to repay the capital sum if the customer demands it. Some do and others decide to leave it in place for another year or two.