Reading Time: 4 minutes

When Banks Crash

It doesn’t happen too often, but from time to time we hear about a bank that goes out of business or crashes.

There have been some famous examples including SA’s own Saambou and African Bank (the old one, not the new one with the same branding but different licence number)

You may wonder though, how do banks get into so much trouble that they collapse?

Borrowing & Leveraging

You “need money to make money”, that’s how the saying goes.

One of the main reasons why some banks have recently collapsed, is because of their heavy reliance, on borrowing money themselves, and then leveraging those funds to make money before they have to pay it back.

Banks do not have bank vaults full of gold, like in the old days. In modern times money is mostly 1’s and 0’s on a computer. In fact, you might even find that banks give people loans that are based almost totally on the promise of money that the client will eventually pay back. Still, banks are required to have at least some of the money they lend out or use.

Banks borrow money from depositors (their savings clients) and other creditors (like the Reserve Bank or bondholders) and then in turn, they use that money to grant loans and investments. This process is known as leveraging, and it can amplify profits when things are going well.

However, it can also magnify losses when things turn sour.

Since banks have borrowed money, they also have to pay it back. To do that, they need to be making a profit or they will have to borrow even more money to make payments back to their investors or the Reserve Bank.

What is a Run on the Bank?

When news gets out that a bank’s share prices are dropping, or that some of their investment plans are not working out as expected, this can cause their clients to panic, causing what is known as a run on the bank.

A “run on the bank” happens when lots of people all worry that a bank might not have enough money to give back to all of its customers. They try to withdraw all of their money at the same time, which can cause big problems for the bank. Often the situation will snowball from just a few nervous clients, then a few more, then more and more as the panic spreads.

When too many people try to take out their money all at once, it can cause the bank to run out of cash. That’s because banks usually keep only a small amount of their customers’ money on hand, and loan out the rest to other people or invest it in different ways. If too many people try to take their money at once, the bank might not be able to get enough cash in fast enough to return it to everyone.

This can be a big problem because it can cause a bank to go bankrupt. If a bank runs out of money, it really can’t pay back all of its customers, and that can lead to a chain reaction of financial problems for everyone involved. No wonder people panic.

Banks Can and Do Crash

Banks need our money to make money. They need funds sitting in savings accounts and their vaults to run their business.

But these days it is hard for people to save. and so banks have had to rely more and more on borrowing money or selling shares and bonds. 

The challenge is that these investors will give them money, but only if the bank promises them a good return on their investment.  Global markets and global conditions are increasingly hard to predict, this is making consistent profit from investments almost impossible.

These days, investors are fickle and only want the most profitable investments. If things are not profitable, they can easily take their money out and invest elsewhere.

Investing has always been volatile and with the increases in government regulation and the incredible speed of communication these days, it is harder and harder to hide even the smallest financial difficulties and it has become harder to keep investors calm.

These days fickle, nervous, demanding investors and easily panicked clients can quickly withdraw their support and their cash in just minutes. Runs on the bank are becoming more common and investors can quickly dump stock.

When you put all these factors together this is often the reason a bank can crash.