Although banks portray themselves as very solid and dependable institutions - their buildings are often modelled on Greek or Roman temples with massive stone columns in effect declaring 'we're here to stay forever' - in fact they operate on very shaky foundations. What they do is borrow short (customer deposits and interbank loans to the bank are held on a short-term basis) and lend long (loans are provided by the bank on a long-term basis), which is a very hazardous business.[168] In their normal day-to-day business banks have to settle accounts with other banks using BoE reserves as people move money between bank accounts, so at any one time banks that are short of reserves depend on loans from other banks that have a surplus of reserves. If the banks with a surplus become reluctant to lend to the bank with a shortage, or if substantial numbers of depositors want their money in cash, then the bank has to transfer or pay out its liquid assets, which are generally severely limited. It can't use its illiquid assets (customer debts, buildings etc.) because they can't convert them into cash at short notice. If many depositors want their money at the same time then they create a 'run on the bank' and this has happened many times throughout history, the most recent being in September 2007 when customers of Northern Rock formed long queues in fear that they would lose their savings. Borrowing short and lending long is known in the jargon as maturity transformation, which gives the impression that risky short-term borrowings are somehow transformed or converted into safe long-term loans. The truth is much simpler: nothing is transformed, all short-term borrowings remain short-term borrowings, and all long-term loans remain long-term loans. The term 'maturity transformation' gives a veneer of safety and control over a practice that is very risky, especially when banks have a high ratio of short-term borrowings to liquid assets, which they are strongly incentivised by profit to have.
Given the shaky nature of banking the great fear that banks have (and it is a very real fear, especially in downturns) is that their assets will fail to cover their debts, or in other words that they will be insolvent. Since the 2008 crash many banks still hold what are known as toxic assets, things like mortgage backed securities and collateralised debt obligations - mortgage and other debts owed by people across the world that have been packaged together and sliced up into saleable segments - see chapter 54. The problem with these is that no-one, not even those who did the packaging and slicing, knows what they are really worth, and when a rash of mortgage defaults occurred in the US confidence in them evaporated. Because of this they are now all but unsaleable, so in effect they are worth almost nothing. It was this problem that caused banks to stop lending to each other in September 2007 leading to the run on Northern Rock. Banks didn't know whether they themselves or other banks were solvent or not, and wouldn't lend money to another bank for fear of it going bankrupt, in which case they would lose the money that was lent. The BoE is very reluctant to lend to a bank that is insolvent, or even thought to be insolvent, because that risks losing public (i.e. taxpayers') money[169], so there is an enormous incentive for a bank that is close to insolvency to value its assets as highly as possible.
In reality the bank asset/debt balance is completely academic because in a practical sense all banks are insolvent in that none of them can pay all their debts any more than the fraudulent goldsmiths of old could pay all the receipt holders. Although now legitimised and regulated, the original deception remains in the system, and the deception is that banks promise to pay everyone that has an account in credit that they can have their money in cash, either on demand for a current account or on maturity for a savings account. That promise can't possibly be kept because the bank doesn't have access to enough cash, by a very large margin, to be able to do so. Just like the goldsmiths' fraudulent activities modern banking is based on promises that can't be kept.
The banking business is based on deception: banks make promises that they can't keep, yet the economy only functions when the deception is believed.
This fact highlights the contradiction at the heart of modern banking - as long as depositors believe that their money is safe then indeed it is safe because they leave it in the bank, but as soon as they begin to fear that their money is not safe then indeed it is not safe, because everyone rushes to get their own money out in cash before it is all gone. To deal with this contradiction a number of sticking plasters have developed over the years as a result of bitter experience, as discussed in the last chapter, but apart from massive government intervention they are hopelessly inadequate in a serious crisis as was shown in 2008. The one measure that would remove the contradiction - preventing banks from creating money - is one that has not been tried. We shall explore alternatives to the current system in chapter 55.
Note that a solvent bank's ability to borrow from the BoE when it has cash flow problems is a privilege not afforded to other businesses. Many solvent and socially valuable businesses suffer cash flow problems - for example when debtors don't pay on time and creditors demand payment - and those problems often cause the businesses to fail. Neither the BoE nor any other state organisation provides any help to those businesses, which must go cap in hand to their own or another ordinary bank for a temporary loan or overdraft and hope for the best. The bank approached will only lend if it feels sure that the loan will be repaid with interest, in other words it will only lend if its own interests are served, it won't lend purely to help the business.