Banks lend out customer deposits, so a run happens when trust breaks and everyone withdraws at once. The same pattern hits fund managers and crypto exchanges. The US and UK have zero reserve requirements now, leaving no buffer against the next crisis.
Chapters
How banks fail. In the first few episodes in our mini-series on banks, we discussed how banks work. But what happens when they stop working? Banks and other financial institutions, including fund managers and crypto exchanges, tend to fail precisely because of the business model that has made them so successful. In order for a bank to make money, it uses customer deposits to lend to other customers, earning the spread that we talked about in previous episodes. This means that the money that you see in your bank account when you log on to your banking app isn't actually there, as it has likely been lent to another customer. The relationship therefore between me and my bank relies on trust. So what happens when this trust breaks down. Often a few negative news stories about a bank's liquidity, or ability to pay customer deposits, will precipitate what's known as a bank run. As panic sets in, more customers rush to the bank, desperate to get their cash out before the bank goes bust. The same thing has happened with funds and exchanges, where poor performance and negative news prompts demands for immediate redemptions, which which are not possible due to insufficient reserves or illiquid assets. This fragile system does have some guardrails, with the UK and US central banks stepping in to be the lender of last resort, a move aimed at maintaining confidence in the financial system. Many countries also offer deposit protection insurance, meaning that savers aren't out of pocket if their bank collapses. However, in the UK and the US, The Fed's reserve requirements, or the percentage of total deposits required to be held as cash, are currently at 0%, providing a scant buffer for future financial crises.
