Is the following statement about why banks can fail correct? if banks use there excess reserves to make loans,then that means they use the depositors money to make the loans.so how can banks create money if they are using the depositors money.you are basically using the same money over and over again.that is why if people are not confident and they want to remove there money from the bank, the bank fails and closes its doors because it loaned out the people's money, it does not have that money in the bank. is this correct?

Expert Answers

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If you are mainly asking about why banks fail and whether they can fail in the situation you describe, you are absolutely right.

Banks do not keep their depositors' money on hand in their vaults. They lend it out so they can make money. If all of a bank's depositors demanded their money at the same time, the bank would fail because it could not get enough money to pay them all.

Because of that, our banking system is based largely on confidence and trust. That is one reason the Congress created the FDIC back in the Depression -- so that no one would need to worry about losing their money if their bank went broke.

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