The business of banking, it is often said, is “maturity transformation,” or “borrowing short to lend long.” A classic simple bank funds itself with deposits — people put their money in the bank with the understanding they can withdraw the entire amount they put in at any time — and uses those deposits to make mortgages and loans that won’t be repaid for years. If all the depositors want their money back at the same time, the bank won’t have enough money to pay them back immediately, and bad things will happen.
This is called a “bank run” and is one of the best-known problems in finance. It is, for instance, a plot point in “It’s a Wonderful Life.” There are several equally well-known ways to address it: inspirational rhetoric (the George Bailey solution), reserve requirements and a lender of last resort to try to make sure the bank can get enough money, capital requirements and deposit insurance to make banks safer and runs less likely. It all works pretty well.
