![]() In this the FDIC actually protected bank accounts that exceeded the insurance limit as well, because the best way to not lose money was to put it in a bank that didn’t fail. The impact of this insurance was less about what was paid out and more about its existence: the idea - and effect - was to stop bank runs before they even started, because depositors didn’t need to worry that they would lose their money. What ultimately stopped the contagion was the establishment of the Federal Deposit Insurance Corporation in 1933: the FDIC, which was funded by member banks, insured $2,500 per account even if a bank went out of business depositors would get their money back. This is what happened in the Great Depression: 650 banks failed in 1929, and more than 1,300 in 1930 over 9,000 banks would fail in total. Moreover, bank runs can be contagious: if depositors hear about a bank run at another bank, they may start to question the safety of their deposits in their own bank, starting another run. ![]() Unfortunately a bank run can become a self-fulfilling prophecy: if depositors fear that a bank is running out of liquid assets, then the rational response is to quickly pull their funds, which makes the problem worse. ![]() The reason this works is because a bank ideally has a diverse set of depositors, whose funds come and go on an individual account basis, but on an aggregate basis are steady this provides the stability for those long-term loans.Ī common failure mode for banks is a bank run: a bank does not have sufficient assets to pay back all of its depositors at once, because those assets have been distributed elsewhere as loans. ![]() Banks achieve this by leveraging time: depositors earn a lower interest rate in exchange for being able to withdraw their money at any time loans earn higher interest rates, but take years to pay back. A bank is profitable if the interest rate they charge for loans is greater than the interest rate they pay to depositors. Banks are, at their core, facilitators: depositors lend their money to a bank, for which they are paid interest, and banks lend that money out, again for interest.
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