Personal Finance

Idk, it's not that different, just a lot more complicated. If the bank doesn't have the cash to sell a loan, they'll buy that cash from another institution that does have it to give the cash to the borrower. At the end of the day, the cash needs to exist for the bank to issue the loan, the bank just doesn't need to have the cash itself, and the bank can buy cash from banks with other assets (i.e. loans). Interest on customer deposits are cheaper than buying cash from other banks, so banks want to attract more deposits.

So if we bring it back to grandma, let's say we do something like this:

1. you borrow $10k from grandma at 5%
2. your friend (A) borrows $8k from you at 10%
3. your friend loans $6k to another friend (B) at 15%

And here's how the various accounts look:

• grandma - $10k IOU
• you - $2k cash, $8k IOU, -$10k loan
• A - $2k cash, $6k IOU, -$8k loan
• B - $6k cash, -$6k loan

If we only look at the asset column, we get $34k. That's essentially how banks work, but on a broader scale. If grandma calls your loan, you'd only be able to hand her $2k immediately, but you would probably eventually get the full $10k (and maybe some profit) from A, who would get it from B. But if she really needs the full $10k now, you'd both have a problem.

And that's where the FDIC comes in. Let's say you were FDIC insured, and grandma instead gave you $10k as a deposit (not a loan). If she wanted the full $10k and you weren't able to provide it, she could go to the FDIC to get that money, and the FDIC would take over your bank to get the cash from A and then B (though grandma doesn't have to wait for that).

So really, the modern banking industry isn't really any different from borrowing from grandma, it's just a lot more complex because there are more moving parts.