LONDON — Mortgage lending is inevitably long term. To cover such lending, banks depend on deposits by savers that may well be short term. If banks don't have enough deposits to cover their loans, they have to borrow on the interbank market. Banks are required to carry enough cash to cover up to five days of normal outgoings.
When banks are basically sound and solvent, there is no problem with these arrangements. But circumstances have not been normal recently amid fallout from the subprime mortgage problem in the United States.
Many of these loans were securitized, packaged and repackaged. Other banks accepted these securities often without adequately assessing the risks involved. As the ripples spread overseas, banks became increasingly reluctant to lend to one another against securities of doubtful value. Hedge funds seemed to grasp quickly that some mortgage institutions dependent on interbank borrowing were in a squeeze, and began short-selling shares in these institutions.