How do Banks go bust? Why do banks borrow money from other banks?
Banks have savers. These deposit billions with the banks. The banks use this money to generate more money by using this cash to give out mortgages and loans ect.... Eventually, the banks get close to using all the savers money. So they borrow from other financial institutions to carry on giving out mortgages. And of course these lenders need a return on their loans.
The lenders lend the money as the cash the banks use for mortgages and loans is deemed safe. The only catch is it will take 25 years for the return on a mortgage to be fulfilled. So in short, the banks aren't skint. It's just that their cash is tied up in long term financing.
Lenders then see that the money markets are doing poorly and refrain from lending to the banks. The speculators name the banks who have been refused a loan, the bank finds it difficult to continue giving out mortgages as all their cash it tied up, the public get tipped off that their bank is having difficulties, and the savers start pulling all their money out. Eventually, the bank has no more money to pay savers taking their cash elsewhere so have to call for help. Going to shareholders who are reluctant giving cash to the bank as their will be no return seeing as everyone is pulling out. The shares continue to nosedive, more savers leave the sinking ship, eventually the bank can no longer operate.
Yes, techically, the banks grind to a halt and can no longer operate due to lack of funds but remember, they have billions out their that will take 25 years to be returned from mortgages ect... Mortgages still have to be paid so whoever buys the bank, wether it be another bank or a government, will eventually get their money back although over many years.
The only real risk in all this is if a full blown recession happens and people cannot pay back their mortgages. Bad debt will take a chunk of this buyout money but when you default on a mortgage, your home will be repossessed. And with house prices heading downwards, it could be difficult to raise the cash to completely cover bad payments.
With the buyouts of Northern Rock and now Bradford and Bingley by the government, if we have a harsh recession, we could well have a situation where the state owns many thousands of once private houses when the dust clears.
With Bradford and Bingley. The government could just sit with the bank for 25 years, giving out no more mortgages, just collecting the payments. And when all is done and dusted, end up with the billions the bank started off with plus the profits for charging for finance. Pay back the taxman who bought the bank out, and have money left over. If all goes well of course. So there is the possibility that long term, the government could make money on their investment.
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