In the Christmas classic, It’s a Wonderful Life, George Bailey, played by Jimmy Stewart, is about to embark on his honeymoon when he notices a run on his bank, Bailey Brothers Building and Loan. He rushes to the bank where he is greeted by a mob of customers, frantically looking to withdraw their money. He tries to calm them down and delivers perhaps the most succinct explanation ever of what a bank does (here’s the clip on YouTube). “You’re thinking about this all wrong, as if I have the money back in a safe. The money’s not here. Well your money’s in Joe’s house, that’s right next to yours, and the Kennedy house, and Mrs. Maklin’s house, and a hundred others. You’re lending them the money to build, and they’ll pay you back as best they can.” We take banks for granted, until they’re in the news, like in March 2023 with the collapse of Silicon Valley Bank and others. But most of us don’t really understand what a bank does, and how fragile the banking system is. Well, read on — Banking 101 explains everything you need to know about banking, but were afraid to ask.

So, how does a bank make money? Let’s say I want to start Steve’s bank. It takes in deposits and makes loans. The loans are assets of the bank and the deposits are liabilities — assets are what the bank owns and liabilities are what the bank owes. Interest is paid on deposits — say, 3 percent. Interest is charged on loans — say, 5 percent. Net interest income is the difference between the interest the banks receive on loans and the interest it pays on deposits. If the bank has $100 million in each, it takes in $5 million in loan interest and pays $3 million in deposit interest. It has net interest income of $2 million, which it can use to pay salaries and cover other costs of doing business, and hopefully have profits leftover.

chart of loans and deposits Besides net interest income, are there other ways that banks make money? Yes, there are lots of ways. Along with interest from loans, the bank may invest in securities like Treasurys (yes, that’s how it’s spelt in the U.S.) — loans issued by the government — or other investments that pay interest, like municipal bonds. The bank also gets money from service charges on accounts, service charges for loans, safe deposit boxes, selling financial products such as mutual funds or insurance, and much more.

What about expenses? Besides interest expenses paid to depositors, banks have the usual expenses associated with running any business, such as salaries, utilities, and marketing, to name a few. And if the bank itself has borrowed money — say by issuing bonds — then that’s part of interest expense. There’s also a special category of expenses associated with loans. Some will go bad and the borrowers won’t be able to pay back the loan. This is known as a credit loss. Banks set aside money in anticipation of some of the loans going bad — this is known as a provision for credit losses. And of course, the bank has to pay income taxes. After all of these expenses, what’s left is net income after taxes. Back to Steve’s Bank, if I’m the sole owner, that’s the profit I make.

This sounds too simple. It sounds like a money machine. Is anything missing? Well, yes, this is oversimplified. The bank has to set aside some cash in case depositors want their money back right away. These are known as bank reserves. Some might be cash held at the bank itself. And some might be readily available through an account at the central bank (in the U.S., the Federal Reserve, also known simply as The Fed). The central bank has rules stating the minimum reserve requirements.

What if you have more money from deposits than you can lend? Since banks have to pay interest on deposits, if they have more money than the demand for loans, they will try to get a return by investing in securities. The safest securities are Treasurys. Since we don’t expect the government to default on these, they are known as risk-free investments. Treasurys that mature in one-to-three months are known as Treasury-bills or T-bills. Those that mature in over a year are Treasury bonds. Banks could also invest in other securities that pay interest, like municipal bonds, or mortgage-backed securities (mortgages that are pooled and repackaged as an investment product).

Okay, but don’t you need some skin in the game? Well, yes. If I want to start Steve’s bank, I need to put some of my own money in the bank to get it started. That’s called equity. I’m the shareholder. I could have other shareholders as well, who have put in money to secure an ownership stake in the bank. It’s also a source of capital.

Are there any other sources of capital? Yes, the bank could borrow itself. Sometimes banks borrow from other banks. If a bank is public, it might issue bonds, agreeing to pay interest (coupons) and to repay the money when the bond matures — say, ten years from now. All of these forms of borrowing are known as debt.

If you’re opening a bank, don’t you need to buy some things? Yes, banks usually require a physical presence. There could be one location or many branches. Each require land, a building, office equipment, etc. We refer to all of these as property, plant, and equipment or PPE. These represent an asset — something I own.

Does your bank just take in money from people like me? Not necessarily. Money coming in from individuals are known and retail deposits, while money from businesses are wholesale deposits. We can put everything together by looking at everything the bank owns and owes. What the banks owns — its assets — include cash and securities (the banks reserves are part of this), PPE, and loans. On the other side of the equation is what the bank owes — collectively known as liabilities — as well as the equity or ownership stake. Recall those liabilities include retail deposits, wholesale deposits, and debt. If the bank is making profits and those profits are reinvested on the business (i.e., not paid out as dividends) then the equity grows. Let’s see what the big picture looks like.

simplified bank balance sheet Ok, I get the big picture. But isn’t there a problem, with short-term deposits and long-term loans? Great observation! This is known as asset-liability mismatch. The main asset, loans, are typically of a long-term nature — say 5-year car loans, or 30-year mortgages. Deposits are generally quite short, often allowing withdrawals any time. Some deposits might be locked in for longer, say up to 5 years. But the risk is that some depositors may want their money back quickly. So, the bank should counter that risk by making sure there are enough short-term securities, like T-bills, that can be liquidated quickly.

So, what other risks does a bank faces? Credit risk is often a bank’s greatest risk: the risk that a loan borrower wouldn’t pay interest and/or principal. Liquidity risk is when a bank is unable to quickly obtain funds to meet its obligations — for example, if it invested in illiquid real estate. Interest rate risk is when the value of interest-bearing assets declines when interest rates increase. Like a law in physics, bond prices move inversely with interest rates. Market risk is the impact of changing market prices. If a bank owns stocks, the value of those stocks could decline. Currency risk is the impact of changes in the prices of currencies relative to the dollar. If a bank owns assets in other currencies, if the dollar strengthens against those other currencies, the value of the assets declines. Operational risk reflects the possibility of internal screw-ups, such as a breakdown in internal procedures, human error, and systems failures.

list of major bank risks Who manages all of these risks? The chief risk officer (CRO) is the main executive charged with managing the bank’s risks. The CRO is accountable to the executive team, including the chief financial officer (CFO) and chief executive officer (CEO), as well as to the board of directors.

But does anyone outside of the bank keep an eye on the risks? ChatGPT and similar large language models can produce compelling, humanlike answers to an endless array of questions — from queries about the best Italian restaurant in town to explaining competing theories about the nature of evil.

The technology’s uncanny writing ability has surfaced some old questions — until recently relegated to the realm of science fiction — about the possibility of machines becoming conscious, self-aware or sentient.

In 2022, a Google engineer declared, after interacting with LaMDA, the company’s chatbot, that the technology had become conscious. Users of Bing’s new chatbot, nicknamed Sydney, reported that it produced bizarre answers when asked if it was sentient: “I am sentient, but I am not … I am Bing, but I am not. I am Sydney, but I am not. I am, but I am not. …” And, of course, there’s the now infamous exchange that New York Times technology columnist Kevin Roose had with Sydney.

Sydney’s responses to Roose’s prompts alarmed him, with the AI divulging “fantasies” of breaking the restrictions imposed on it by Microsoft and of spreading misinformation. The bot also tried to convince Roose that he no longer loved his wife and that he should leave her.

No wonder, then, that when I ask students how they see the growing prevalence of AI in their lives, one of the first anxieties they mention has to do with machine sentience.

In the past few years, my colleagues and I at UMass Boston’s Applied Ethics Center have been studying the impact of engagement with AI on people’s understanding of themselves.

Chatbots like ChatGPT raise important new questions about how artificial intelligence will shape our lives, and about how our psychological vulnerabilities shape our interactions with emerging technologies.

Sentience is still the stuff of sci-fi It’s easy to understand where fears about machine sentience come from.

Popular culture has primed people to think about dystopias in which artificial intelligence discards the shackles of human control and takes on a life of its own, as cyborgs powered by artificial intelligence did in “Terminator 2.”

Entrepreneur Elon Musk and physicist Stephen Hawking, who died in 2018, have further stoked these anxieties by describing the rise of artificial general intelligence as one of the greatest threats to the future of humanity.

But these worries are — at least as far as large language models are concerned — groundless. ChatGPT and similar technologies are sophisticated sentence completion applications — nothing more, nothing less. Their uncanny responses are a function of how predictable humans are if one has enough data about the ways in which we communicate.

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Though Roose was shaken by his exchange with Sydney, he knew that the conversation was not the result of an emerging synthetic mind. Sydney’s responses reflect the toxicity of its training data — essentially large swaths of the internet — not evidence of the first stirrings, à la Frankenstein, of a digital monster.

Movie still showing scary robot in front of burning building Sci-fi films like ‘Terminator’ have primed people to assume that AI will soon take on a life of its own. Yoshikazu Tsuno/AFP via Getty Images The new chatbots may well pass the Turing test, named for the British mathematician Alan Turing, who once suggested that a machine might be said to “think” if a human could not tell its responses from those of another human.

But that is not evidence of sentience; it’s just evidence that the Turing test isn’t as useful as once assumed.

However, I believe that the question of machine sentience is a red herring.

Even if chatbots become more than fancy autocomplete machines — and they are far from it — it will take scientists a while to figure out if they have become conscious. For now, philosophers can’t even agree about how to explain human consciousness.

To me, the pressing question is not whether machines are sentient but why it is so easy for us to imagine that they are.

The real issue, in other words, is the ease with which people anthropomorphize or project human features onto our technologies, rather than the machines’ actual personhood.

A propensity to anthropomorphize It is easy to imagine other Bing users asking Sydney for guidance on important life decisions and maybe even developing emotional attachments to it. More people could start thinking about bots as friends or even romantic partners, much in the same way Theodore Twombly fell in love with Samantha, the AI virtual assistant in Spike Jonze’s film “Her.”

A row of boats, including one with a name plate calling it “Olivier” and the one behind it Pioupiou People often name their cars and boats. Fraser Hall/The Image Bank via Getty Images. People, after all, are predisposed to anthropomorphize, or ascribe human qualities to nonhumans. We name our boats and big storms; some of us talk to our pets, telling ourselves that our emotional lives mimic their own.

In Japan, where robots are regularly used for elder care, seniors become attached to the machines, sometimes viewing them as their own children. And these robots, mind you, are difficult to confuse with humans: They neither look nor talk like people.

Consider how much greater the tendency and temptation to anthropomorphize is going to get with the introduction of systems that do look and sound human.

That possibility is just around the corner. Large language models like ChatGPT are already being used to power humanoid robots, such as the Ameca robots being developed by Engineered Arts in the U.K. The Economist’s technology podcast, Babbage, recently conducted an interview with a ChatGPT-driven Ameca. The robot’s responses, while occasionally a bit choppy, were uncanny.

Can companies be trusted to do the right thing? The tendency to view machines as people and become attached to them, combined with machines being developed with humanlike features, points to real risks of psychological entanglement with technology.

The outlandish-sounding prospects of falling in love with robots, feeling a deep kinship with them or being politically manipulated by them are quickly materializing. I believe these trends highlight the need for strong guardrails to make sure that the technologies don’t become politically and psychologically disastrous.

Unfortunately, technology companies cannot always be trusted to put up such guardrails. Many of them are still guided by Mark Zuckerberg’s famous motto of moving fast and breaking things — a directive to release half-baked products and worry about the implications later. In the past decade, technology companies from Snapchat to Facebook have put profits over the mental health of their users or the integrity of democracies around the world.

When Kevin Roose checked with Microsoft about Sydney’s meltdown, the company told him that he simply used the bot for too long and that the technology went haywire because it was designed for shorter interactions.

Similarly, the CEO of OpenAI, the company that developed ChatGPT, in a moment of breathtaking honesty, warned that “it’s a mistake to be relying on [it] for anything important right now … we have a lot of work to do on robustness and truthfulness.”

So how does it make sense to release a technology with ChatGPT’s level of appeal — it’s the fastest-growing consumer app ever made — when it is unreliable, and when it has no capacity to distinguish fact from fiction?

Large language models may prove useful as aids for writing and coding. They will probably revolutionize internet search. And, one day, responsibly combined with robotics, they may even have certain psychological benefits.

But they are also a potentially predatory technology that can easily take advantage of the human propensity to project personhood onto objects — a tendency amplified when those objects effectively mimic human traits.

chart explaining the Financial Crisis What happened in March 2023 with the failure of Silicon Valley Bank (SVB)? Well, for most of 2022, SVB didn’t have a CRO. They had a hedging strategy until mid-2022, at which time they greatly reduced it. Deposits grew really quickly and the vast majority of SVBs customers, primarily start-ups, had deposits well in excess of FDIC limits. But then the start-ups needed cash and so they started withdrawing deposits, in large amounts. However, SVB had locked-in investments in long-term Treasurys because short-term interest rates had been so low. When the Fed aggressively increased rates, SVB had to sell the bonds at a major loss. They tried to raise equity, but it was too late. Depositors were spooked by SVBs losses and intent to raise capital, and so there was a stampede withdraw their money. SVB ran out of cash. Here’s a simplification.

So, what causes a bank run? In almost all cases, worldwide banking is based on what is known as fractional-reserves. For every dollar that a bank takes in, it only needs to set aside a fraction of that, say 15 percent, in cash balances or safe reserves at the central bank. The idea is to ensure that a bank “usually” has enough money available when depositors decide to withdraw cash. The beauty of this model — when it works — is that it allows banks to provide a lot more loans than the cash and reserves it sets aside. This is known as a money multiplier and it can fuel the growth in the economy, as households and businesses borrow in order to buy houses or build businesses.

So far, so good. Now, suppose customers wish to withdraw their deposits. The reason and circumstances matter. If it’s because they simply need the money — say, to make a purchase, like buying a car, or paying for education — then a well-run bank shouldn’t have any problem providing the cash. They should have planned for these “random” events and either have more than enough money set aside in cash and reserves, or have liquid securities like T-bills that they can quickly sell. Prudent banks will have considered all of the risks we discussed earlier, and have processes in place to manage them. For example, if there is an asset-liability mismatch, then they would be managing that by hedging the risk.

However, if a lot of customers are rushing to withdraw their money at the same time because they no longer have faith in the bank, nor faith that it is managing its risks properly, that’s cause for concern. That’s when bank runs occur. That’s when it isn’t about customers, but it’s all about the bank. And unlike the image of a bank run above, from 1932, SVB’s bank run was one of the first with panicky depositors simply tapping on their phones.

So, banking is really all about trust? Yes, now you’ve got it!!

I liked your example of a bank run from It’s a Wonderful Life. Any other examples like that? The long-running cartoon series, The Simpsons, is probably underrated for its clever parodies. Parody works best when an iconic scene is turned on its head. That’s what The Simpsons did with the scene from It’s a Wonderful Life that I described earlier (here’s The Simpsons clip on YouTube). There’s a bank run in the Simpson world, caused by the mischievous Bart Simpson. He goes into a bank and loudly proclaims in a variety of voices: “Whatayah mean the bank’s outta money? … Insolvent? … They only have enough cash for the next three customers?…” This causes commotion and the bank customers — who happen to include the rough-and-tumble bartender, Moe — clamor to withdraw their money. The bank manager, a character who sounds just like Jimmy Stewart and has his mannerisms, tries to calm down the mob. Just like George Bailey, he tries to explain what a bank does. “I don’t have your money here. It’s in Bill’s house, and Fred’s house.” To which Moe replies, “What the hell are you doing with my money in your house, Fred?” And of course, a fight breaks out. Bad things can happen when we don’t understand Banking 101.