How does a bank - short of cash - make up the difference. In normal
times everyone understands that most banks have perfectly good assets which turn
into cash at a more-or-less predictable rate. As the assets - like bank
loans and mortgages - get paid off by the bank's borrowers there will usually be
enough cash to pay customers who want cash. Occasionally there are
anomalies, which leave a bank a bit short of cash. This is not a problem.
The bank will issue a special 'note' to another bank which is a promise to pay
cash at some time in the near future, and receive cash now in return. All
it requires is for banks to be generally trusting of each others
creditworthiness, and they usually are. But when there is a credit crunch
each bank is sufficiently wary of any other that none gives cash out. Then
the lender of last resort - usually the central bank - steps in and makes the
loan. In generally accepted banking practice the lender of last resort
will save banks which have a liquidity problem (i.e. their assets cannot be
easily turned into cash, although they remain valuable). Equally they will not
rescue banks which are insolvent - meaning their assets are actually worth less
than their liabilities. It is never an easy call.