When a bank fails, there are systems in place to protect consumers’ deposits and ensure that consumers don’t lose money. As long as your money is in an FDIC-insured institution, it’s safe, even if your bank ceases to operate. Fortunately, bank failures are incredibly rare.
This article will explain what a bank failure is, why banks fail, how to spot the signs of a bank failure, the history of bank failures in the United States, and the steps to take in the unlikely event that your bank fails.
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What is a bank failure?
A bank failure is when a federal or state banking regulatory agency closes a bank because the bank is insolvent or has reached illiquidity. Insolvency is when a bank has more debts than assets, and illiquidity is when a bank doesn’t have enough money available to meet customers’ withdrawal requests.
To protect consumers, President Franklin Roosevelt signed the Banking Act in 1933, which created the Federal Deposit Insurance Corporation (FDIC). The FDIC steps in when banks reach the point of collapse and protects customers’ assets by returning them to the customer or moving them to a different banking institution.
Why do banks fail?
The Federal Reserve Bank of New York recently created a panel explaining the most common reasons for bank failures:
- Rising asset losses: Banks make money by investing in assets, but if the assets lose value, this can cause banks to fail.
- Deteriorating solvency: Solvency is when a bank has more assets than liabilities. When a bank experiences the reverse, it means it would be unable to give all customers their money if they all requested it at once.
- Weak fundamentals: The Federal Reserve Bank said that weak fundamentals are the basis for most bank failures. This covers a range of issues like risky investments, poor management, lack of investing diversity, fraud, or having uninsured deposits. For example, 85% of Silicon Valley Bank’s deposits were not insured.
Signs of potential bank failure
Financial experts from Florida Atlantic University report that many banks show warning signs before a bank failure. Here are some examples of these risk factors:
- Negative news reports about a bank’s financial troubles can trigger a bank run, which is when a large number of a bank’s customers withdraw their money due to concerns the bank is failing.
- When banks have investment losses greater than their assets, that’s a red flag.
- Rising interest rates can negatively affect banks, especially those that sold bonds when interest rates were much lower.
- Large bank withdrawals can indicate that customers don’t believe a particular bank is safe.
- Bank stocks dropping could also be an indicator of overall financial instability.
Finally, banks have credit profiles, much like consumers do. If agencies, like Moody’s and Fitch, downgrade their ratings of banks, it could be a sign of potential trouble. Just one of these indicators doesn’t necessarily mean a bank will fail. However, a combination of them or prolonged periods of bank instability can cause a bank failure.
What happens when a bank fails?
Here is what happens when a bank fails, step by step:
- Step 1: The FDIC takes over: The FDIC takes control of the assets of a failed bank and seeks to sell them to healthy financial institutions. In fact, the FDIC may begin selling a failing bank’s assets even before it officially fails.
- Step 2: The FDIC notifies and reimburses customers: If a customer had assets under the $250,000 FDIC insurance threshold, the FDIC will either reimburse customers or move customers’ deposits to a healthy bank. The FDIC will notify customers of the status of their deposits.
- Step 3: The FDIC sells bank assets: Customers with deposits above the FDIC insurance threshold must wait for the FDIC to sell off more bank assets. It’s possible, but not guaranteed, that these customers can recover some of their funds.
- Step 4: Customers set up new accounts: Customers who received checks can deposit their money at a different bank. Customers who have been assigned a new bank will need to set up accounts and usernames with their new financial institution. This includes setting up new automatic payments for outstanding loans.
What happens to your money when a bank fails?
If you’re a customer of a bank that fails, what happens to your money depends on whether the bank was FDIC-insured and how much money you had in the bank. If your bank was FDIC-insured and you had under the FDIC threshold, your money is safe. The FDIC will return it to you or transfer it to a healthy bank.
Assets above $250,000
If you had assets in the bank above the $250,000 FDIC threshold per ownership category, those funds are uninsured. It’s still possible to recover them, but the FDIC prioritizes insured deposits first. Once insured deposits go out, then the FDIC moves on to uninsured deposits, general creditors, and stockholders.
The FDIC says it could take several years to recover assets from failed banks, and reimbursement is not guaranteed for uninsured losses.
Safe deposit boxes
The FDIC does not insure items you keep in safe deposit boxes at a bank. If you store valuables there, like jewelry, consider getting a separate insurance policy. How quickly you can access your safe deposit contents after a bank failure depends on how quickly another institution takes over your bank.
Loans
If you have a loan with a bank that fails, you are still responsible for paying the loan. You will get a notice from a new lender explaining how to continue paying the loan. The FDIC says that selling your loan to a different bank doesn’t affect the terms. In other words, your loan will still have the same interest rate, monthly payment, and length as it did with your original lender.
Examples of bank failures
According to the Pew Research Center, there was an average of 3.6 bank failures per year between 2015 and 2022, and there are just under 4,000 FDIC-insured banks in the United States. That’s a sharp contrast to the average of 635 banks that failed each year between 1921 to 1929 and a decline from the average of 5.3 banks that failed between 1941 and 1979.
The largest bank failure in U.S. history happened in 2008 during the financial crisis. Washington Mutual, which had $300 billion in assets, failed due to the subprime mortgage crisis. The FDIC stepped in, and JPMorgan Chase acquired Washington Mutual Bank’s assets and deposits.
There were relatively few bank failures following Washington Mutual’s closure; however, in 2023, several banks did fail, including Signature Bank in New York, Silicon Valley Bank in California, and First Republic Bank in California. In all three instances, the FDIC stepped in, protected customers’ deposits, and other banks acquired the failed bank’s assets.
What to do if your bank fails
If your bank fails, try your best not to panic. If it’s an FDIC-insured bank, your money is safe, as long as you’re under the insurance threshold. As a first step, confirm your bank’s failure by going to the FDIC Failed Bank List, which maintains the official list of confirmed bank failures. Then, wait for FDIC instructions.
The FDIC will inform you about the next steps quickly. You’ll get information about whether your deposits are going to a new institution or whether you’ll receive a check in the mail. Monitor your accounts closely and avoid attempting to withdraw money, as this can complicate the process. If you have automatic payments withdrawing, stop them or redirect them to another account.
You should be able to access your money again in as little as one business day. If you have further questions, contact the FDIC customer service line at 1-877-ASKFDIC (1-877-275-3342).
How to protect yourself against bank failures
The most important step to take to protect yourself against bank failures in the future is to choose an FDIC-insured bank. Then, make sure not to exceed $250,000 in deposits in each FDIC ownership category.
If you have more than $250,000 to deposit in an ownership category, spread out your money across multiple FDIC-insured banks. That way, if one bank fails, you still have access to your money until the FDIC steps in and either returns your deposits or redirects them to a new account at a different bank.
It’s also a good idea to stay on top of the latest financial news, so you’re among the first to hear if one of your banks is heading towards collapse. If you have any questions or are still uncertain about keeping your money safe in the event of a bank failure, you can use a service like Money Pickle to schedule a free financial advising session, no strings attached.
