Monday, July 9, 2018

How Are Banks Able to Borrow Short-Term and Lend Long-Term?

At the post, A Major Economic Indicator Looks Like It May Start Flashing Danger Soon, D.K asks:
Can you help me understand: "banks tend to borrow a lot of funds short-term and lend them out long-term." - how does the bank manage the period of time between when they are due to have completely paid back the funds they borrowed until the funds they lent out are completely repaid? Do they simply borrow the outstanding balance due short-term again, rinse and repeat until completely repaid by the end customer? If so, lets say in this example the bank's long term lending is a fixed rate apr for the end customer how does the bank navigate through an environment of rising interest rates? Every question I ask is producing more questions in my mind so I will leave it at that. Any help in understanding this would be greatly appreciated, Thanks.
Yes, it is pretty much rinse and repeat under the Federal Reserve fractional reserve system. Though, the Fed Funds market acts as a very short-term source if a bank needs funds immediately.

Navigation through a period of short-term rates climbing is very tricky for banks especially if the yield curve is negative  (discussed in the post). That's why banks don't make as many loans when the yield curve is negative, it is generally unprofitable.

Murray Rothbard has a much fuller explanation of what goes on in his book, The Mystery of Banking.


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