3.2.4.4 - Financial regulation and stability

Maturity mismatch and bank failure

A bank can fail because it cannot meet payments when due, because losses exhaust its capital, or because these problems reinforce one another.

Banks often borrow short term and lend long term. Deposits can be withdrawn quickly, while a mortgage may be repaid over decades. This maturity transformation makes useful long-term finance possible without requiring every saver to lock funds away for the same period. The mismatch also creates risk: the bank cannot normally demand immediate repayment of every sound mortgage when depositors want money today.

Illiquidity means insufficient readily available funds to meet payments. A bank may own valuable loans yet be unable to sell them quickly without a discount. Balance-sheet insolvency means assets are worth less than liabilities. Losses first reduce and exhaust equity; further losses then leave creditors' claims uncovered. Borrower defaults, falls in securities prices, poor risk control or losses on trading can weaken solvency. Capital is loss-absorbing funding, not a synonym for cash.

A bank run occurs when many depositors try to withdraw at once. Fear of others withdrawing can make each depositor want to withdraw first, even if the bank's long-term loans are sound. Emergency asset sales may depress prices and crystallise losses, turning a liquidity problem into a solvency problem. Conversely, genuine losses can trigger withdrawals or the loss of short-term wholesale funding. Funding concentrated in a few nervous lenders can make this process especially rapid.

The relevant evidence depends on the problem. Readily realisable assets and withdrawal needs matter for liquidity; asset losses relative to equity matter for solvency. Higher profitability last year does not prove a bank can meet today's payments, and a large portfolio of loans does not prove those loans will be repaid.

UK regulatory responsibilities

Financial regulation combines supervision of individual firms, system-wide resilience and the way firms treat customers and markets.

The following high-level roles were checked against official institutional pages on 1 October 2026. Detailed rulebooks and current numerical thresholds are outside this lesson's scope.

An individual bank might pass a narrow check yet still contribute to system-wide risk if many banks hold the same vulnerable assets. This explains why the PRA's individual-firm focus and the FPC's system-wide focus complement each other. The FCA's conduct role also matters: misleading products or market abuse can harm customers and undermine confidence. The bodies cooperate; their functions are not four independent guarantees that failure can never happen.

Sources: Bank of England, PRA, Bank of England, FPC, and FCA, About the FCA, updated 9 July 2026.

Liquidity and capital buffers

Liquidity and capital requirements strengthen different aspects of a bank's resilience.

A liquidity ratio compares suitable liquid resources with a relevant measure of payment obligations or funding needs. The exact definition matters: some regulatory measures consider stressed outflows, rather than simply all deposits. Holding a stronger liquidity buffer can help a bank withstand withdrawals or disrupted funding without a fire sale. It cannot make a worthless loan valuable again.

A capital ratio relates loss-absorbing capital to a measure of assets or exposures, often adjusted for risk. More capital relative to risk gives a greater cushion before losses threaten creditors or depositors. Raising new equity or retaining earnings can strengthen that cushion. Merely taking more deposits increases liabilities; it does not create the same capital buffer. A high reported ratio can still mislead if asset risks are understated or losses are unrecognised.