Collapse of Banking System

Banks are the medium of exchanging money. Depositors deposit money in the bank and charge interest rates for their deposits where as banks lend money in the form of loan and charge interest. So the system will only function if interest rate on money deposited is less than interest rate over the loan amount. The banks make money in this gap and so are called money creators.

Profits of Bank = Total revenue - Total cost

So it is clear that if total cost goes up i.e. the number of depositors increases than the number of money lenders the system goes wrong. What makes no of depositors increase in the bank which making the system wrong the answer is rise in inflation.

Rise in inflation is fewer money chasing less goods i.e the prices of goods rise due to shortage of demand which decreases the buying power and since the savings of  people increases the money is then deposited in the bank to get the interest. Banks on the other hand has less number of borrowers so the amount of money lending decreases and hence the interest collected is less which increases the total cost of the bank thus decreasing the Profits which might be loss even on the long run leading to collapse of banking system(Eg : Lehman Brothers), leading to recession.

Now in recession banks themselves lend money to large institutions at high interest rates through investment banking system making huge profits and hence recovering previous losses. Them till the time of recovery there is enough money flowing in the economy which increases demand as well as supply where aggregate demand is same as aggregate supply (in Recovery stage). The banks now has enough borrowers and the cycle continues until next collapse.

Concluded the recession stands an opportunity in span of every 7-9 yrs.

Kuldeep H. P
Making love for Economics & Financial Analysis
pitrodakuldeep@gmail.com