试听180秒030：The Dangers of a Bank Run and Financial Instability

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Hello, Himalaya’s subscribers. My name is Timothy Taylor.
Today we're going to discuss the dangers of a bank run and financial instability. Let me start by telling you about what happened last summer in August 2017 at one of the branches of Linshang bank in the town of Linyi in Shandong province. Linshang bank is a medium sized bank. It has about 60 billion yuan in total deposits. 

But a rumor got started that the bank was in trouble. The rumor was that the bank had made some loans to an agricultural processing company, and that company was going broke. So the loans were not going to be repaid. The rumors spread fast. Some people thought, I need to get down to that bank right now and withdraw my money. The worry was if you wait, then other people will go to the bank and take out their money. And when you finally go, there won't be any money left for you. At one point, there were hundreds of people in line trying to withdraw their bank deposits from that bank. And as you can imagine, there was a sense of panic. This behavior is called a bank run. 

When many people are worried that a bank is going broke, they rushed to the bank and all try to withdraw their deposits at the same time. It happens now and then. An earlier example in China was back in march 2014, when a branch of the rural commercial bank of Huanghai in the city of Yancheng had a bank run, ah, happens in other countries too. 

Now what's interesting is there was actually not any reason for the people in Linyi to be worried about their deposits at Linshang bank, because China's government, like most countries around the world, has a policy called deposit insurance, which meant that their deposits were protected for all the ordinary depositors at the bank. But I want to use this idea of a bank run and why people were worried to dig down a little deeper into how banks actually work, and also how deposit insurance works. So let's let's talk about this in three parts. 

First of all, a bank does not actually have everyone's money. Second, when a bank is actually in financial danger, how do we know when that's true and when it's not? And third, why your deposits are safe？Ah, how bank deposit insurance works？ 

So let's start off by talking about first point a bank does not actually have your money. I think some people who are not economists have a mental vision of how a bank operates. The mental vision is like this， the bank takes all your money, it takes the money into a big, locked room, and it puts the money in a big pile. 

When you need some money, they go back into that big room. They get out some of the money, and they hand it to you. Now, as I think, you know at this point, this vision is not true. A bank is not just a big locked room. A bank is a financial intermediary. It takes the deposits it receives and finds ways to lend out that money and invest it. After all, if the bank did not do that and it didn't receive interest payments on the lending, and other returns from its investments, the bank would not be able to pay any interest to its depositors or cover the bank's costs. 

So it is true the bank does not actually have your money. Your money has been loaned out to the business across town, or maybe to some person who borrowed it to buy a house or a car. This is just the normal method of operating for what a bank does. Now, a bank does keep a small amount of cash on hand. So if depositors do want withdraw some cash, there will be some cash available. But most days there aren't going to be a whole lot of people coming to the bank and trying to withdraw all their deposits. 

So what the bank keeps on hand is really a small share of the total deposits. If hundreds of people line up outside a branch of one bank, and they all start trying to withdraw their deposits in the form of cash, the bank will run out of cash most of the time. Now, it might sound as if those people who had deposits in Linshang bank were right to be worried, but not really. And to understand why we need to move to our second point, which is how to tell when a bank is in actual financial danger and when it isn't？

The key issue here is also often described with two economics terms. One is liquidity and the other is solvency. Now you you will remember, I hope that we talked about liquidity before when we talked about financial investing. Liquidity refers to how easy it is to convert your financial investments into something you can actually spend. A bank deposit, for example, is very liquid, but owning stocks or a house is not so liquid. Now, here's the situation with banks. A bank never has enough liquid assets to cover all of its deposits. It can't possibly, because the bank has loaned out and invested most of those deposits. 

But just because a bank isn't liquid doesn't mean that the bank doesn't have financial assets that are have a real value. To understand the difference here, think about this situation. There are two people who owe you money. One of them has no money in the bank, and also has no other financial assets at all. The other person also has no money in the bank, but that other person owns a lot of financial investments, like stock and real estate. 

Now, both of these people are not liquid, but the first person is also not solvent. That is, they owe money and they don't have any financial assets to cover it. The other person is not liquid, but is solvent. That is, the person has financial resources to pay the debt. But it will take a little time to turn those financial assets into a liquid form for payment. In financial markets， it's possible to buy and sell loans. For example, say a bank lends money to a certain corporation, and the corporation agrees to make payments over time with interest. 

Now, that bank could then sell that loan to some other financial institution. If it does this, then the corporation would make the same payments to that other new financial institution. If a bank sells alone in this way, it takes an asset that is not liquid the loan and turns it into cash. If a bank is financially healthy, it could sell off all of its loans, use the money that it gets to pay back all the deposits at the bank. And it would have some amount left over which would belong to the owners of the bank. 

Every healthy bank could put up a big sign out front, and the sign would say, yes, we are not liquid, but we are solvent，so don't worry. Of course, I don't think that sign would make people feel a lot better about that bank, or would avoid a bank run. What about if a bank is not solvent? Remember in the previous lecture, when we were talking about different kinds of costs for banks, we talked about the costs that happen if bank loans do not get repaid or other bank investments lose money. If there's a small or even immediate amount of this happening, that's okay. Banks expect some losses. They also expect some gains. They can plan ahead for moderate losses. But what if the economy as a whole has a big growth slow down or even a recession? 

And lots and lots of people and firms who thought they would be able to repay their loans find they can't do it. What happened all around the world during the great recession in 2008, 2009 was many people had borrowed money to purchase homes and other property, but then the price of real estate dropped, and people had borrowed more than the property was actually worth. If people don't repay their loans, then the bank has losses. And if that bank goes out and says, I want to try and sell my loans. Well, if you're trying to sell a loan from a company that isn't making any more payments on the loan, or you're trying to sell a loan from person who isn't making any more payments on the loan, you can't get very much money while trying to sell that loan. 

So when that bank tries to turn its loans into cash, the bank would not have enough money to pay off its depositors. So that bank is not just illiquid, not liquid. It's also insolvent at the same time. Now we know from the previous lecture that a disruption of banks and the banking system can be very destructive for an economy. If banks stop making loans, other banks have fewer deposits, they make fewer loans. What we called the money multiplier runs in reverse and the result can be melt downs of banks all over the world, which was a big cause of why the great recession of 2008 and 2009 was as bad as it was. 

Now what can government regulators do about all this? How can they try and prevent this from happening? Well, first of all, let's just talk about our third point, which is why your deposits are safe, how bank deposit insurance works. Now, let's first just talk about deposit insurance. I'm sure most listeners are familiar with regular insurance that you might buy. For example, maybe you make payments over time to buy  an insurance policy. And if a bad event happens, then the insurance company makes a payment to you. With life insurance, for example, you make payments， and then if person dies, a benefit is paid out from the insurance company or with property insurance, you might make payments and if a storm damages your property, the insurance company would make a payment. 

Deposit insurance works the same general way, except the banks are the ones who buy the insurance policy. And China enacted a deposit insurance policy three years ago in 2015. Here's how it works. Banks make a payment into an insurance fund. Ah, that payment is a tiny little percentage of bank deposits. In China， it's about 1/100, or 2/100 of a percent of all the deposits. It varies depending on the amount of risk. A bank pays more if it has a lot of high risk loans with a greater chance of not being repaid, or if the bank doesn't seem financially well run to the government financial regulators. 

If a bank does become insolvent, then the deposit insurance fund that's been built up over time make sure that all depositors get their money back at least up to 500,000 yuan for each depositor in each bank. Now that would be a lot of money to have in a bank account, but if you had more than that amount, you could actually split it up into several different banks and each account would be covered by the deposit insurance. This 500,000 yuan limit is enough to cover about 99.6% of all bank accounts in China, but of course it doesn't cover the extremely large amounts that might be held by the very rich or by larger companies. 

Most high income countries and middle income countries across the world, including all the other main economies in Asia, have a deposit insurance program. Once there is a deposit insurance program in place, there is no reason in the world for a bank run anymore, your deposit is protected. If there is deposit insurance in place, what does the government do when a bank run happens? Well, the first step is the government responds by sending out large armored cars full of cash to the bank. Now, this money is really being loaned to the bank. The bank might announce it will stay open 24 hours a day, and anyone who wants to withdraw their cash can have it. 

The idea of doing this is to reassure bank depositors. They can see with their own eyes everyone is going to get their money. No one's deposits are at risk. And a common pattern is when people see they can get their cash if they want it, and the bank run can be over, and everyone can go home and get some sleep. Well, if it later turns out that the bank really was insolvent and it really didn't have the money, then the costs of giving that money to bank depositors would be covered by the deposit insurance program. 

But no matter what, unless you have a really large amount of money that you want to hold in a bank account, rather than invested in some other way. for the ordinary people of China, your bank deposits really are safe. In the next set of lectures, we'll shift the topic slightly and start talking about what a central bank is and what a central bank does. Examples of central banks would be the People’s Bank of China, the US Federal Reserve Bank, the Bank of Japan, and the European Central Bank. 

I'm Timothy Taylor. Thank you for listening to Himalaya.