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January 04, 2010

Money in the vault

Having access to enough money to pay your bills is an obvious requirement for financial well-being, but how does this principle operate at the level of a bank or other financial firm? Could such firms ever not have enough money in the vault?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Well, traditionally banks have found they could keep a lot less than 100 percent of their deposits in the vault. And in fact, what they would do is loan out the rest. And the reason for this is that all a bank's customers are not going to come in at the same time and withdraw their money. Now, indeed, the government sets regulations - they're called reserve requirements - on what percent of deposits have to be kept back in the vault. And these requirements work most of the time. Most of the time, we don't hear about banks having problems. We don't hear about so-called runs on banks. There can be an individual bank here and there, but it's another matter when we have a widespread financial crisis like we had last year. Now, these regulations on required reserves can differ for different types of assets. And one item that has come to the surface is that these requirements weren't as stiff for residential mortgages due to their lower risk. What happened, therefore, over the last four or five years is this motivated banks to really load up on residential mortgages, really push residential mortgages. And some say this helped set the stage for the financial crisis."

Posted by Dave at January 4, 2010 08:07 AM