Bank failures can have devastating impacts on depositors and the economy, but they are rare events that can be prevented or mitigated. A bank failure happens when a bank cannot pay its obligations to its customers, creditors, or regulators, usually because of bad decisions, fraud, external shocks, or regulatory actions. For instance, some recent bank failures include:
- Silicon Valley Bank, which collapsed on March 10, 2023 after losing billions of dollars due to poor risk management, overexposure to crypto deposits and interest rate fluctuations, and a massive run on deposits sparked by social media rumors and panic.
- Signature Bank, which went under on March 12, 2023 after suffering from poor management, over-reliance on uninsured deposits, and contagion effects from Silicon Valley Bank’s collapse.
- First Republic Bank, which failed on May 1, 2023 after being unable to raise enough capital to meet regulatory requirements and facing a lawsuit from the FDIC.
As a depositor, you need to protect yourself from a failing bank to avoid losing your money or facing difficulties accessing your funds. In this article, we will explain what causes bank failures, how to spot the early warning signs of a failing bank, what measures are in place to protect depositors, how to diversify your assets, how to keep yourself informed, how to prepare for a potential bank failure, and what to do if your bank fails.
We will also define some key terms related to bank failures, such as bank liquidity, liquid assets, fdic coverage, bank failure, credit risk, bankruptcy protection, bank insolvency, and safe deposit box.
Finally, we will provide some recent examples of bank failures and some resources for more information on bank failures and deposit insurance.
Understanding Bank Failures
A bank failure is defined as the closure of a bank by a federal or state regulatory agency because the bank is insolvent or in danger of becoming insolvent. Insolvency means that the bank’s liabilities exceed its assets, or that the bank cannot pay its debts as they become due. Bank liquidity refers to the ability of a bank to convert its assets into cash quickly and easily. Liquid assets are those that can be converted into cash without losing much value.
The causes of bank failures can vary depending on the specific circumstances of each case, but some common factors are:
- Economic downturns: When the economy slows down or enters a recession, many businesses and individuals may face financial difficulties and default on their loans. This reduces the income and asset value of banks and increases their credit risk. Credit risk is the risk of loss due to borrowers not repaying their loans.
- Poor management: When banks engage in risky lending practices, mismanage their funds, fail to comply with regulations, or make bad investment decisions, they may incur losses that erode their capital and liquidity.
- Fraudulent activities: When banks or their employees commit fraud, embezzlement, money laundering, or other illegal acts, they may face legal actions, fines, penalties, or criminal charges that damage their reputation and financial position.
The effects of bank failures on depositors and the economy can be severe. Depositors may lose some or all of their money if their deposits are not insured or exceed the insurance limits. They may also face delays or difficulties in accessing their funds or transferring them to another institution. The economy may suffer from reduced lending activity, lower consumer confidence, higher unemployment, and lower economic growth.
The role of regulatory agencies is to monitor the health and performance of banks and ensure that they comply with laws and regulations. They also have the authority to intervene when banks are in trouble and take corrective actions such as issuing orders, imposing sanctions, providing assistance, or closing them down. Some of the major regulatory agencies in different countries are:
- FDIC (US): The Federal Deposit Insurance Corporation is an independent agency of the United States government that insures deposits up to $250,000 per depositor per insured bank. It also examines and supervises banks for safety and soundness and resolves failed banks by selling them to other institutions or liquidating their assets.
- FSCS (UK): The Financial Services Compensation Scheme is an independent statutory fund that protects deposits up to £85,000 per person per authorised firm in the UK. It also covers other financial services such as investments, insurance policies, pensions, and mortgages. It pays compensation to customers when authorised firms fail or are unable to pay claims.
- Relevant agencies in other countries: Different countries have different regulatory agencies and deposit insurance schemes that protect depositors from bank failures. For example, Canada has the Canada Deposit Insurance Corporation (CDIC), Australia has the Australian Prudential Regulation Authority (APRA) and the Financial Claims Scheme (FCS), Germany has the Federal Financial Supervisory Authority (BaFin) and the Deposit Protection Fund (DPF), etc.
Five Early Warning Signs of a Failing Bank
While it is not always possible to predict when a bank will fail, there are some indicators that can alert you to potential problems. Here are some of the early warning signs of a failing bank:
1. Decreased profitability
A bank’s profitability shows how well it uses its resources to generate income. When a bank’s earnings decline or turn negative, it may mean that the bank is facing financial difficulties or losses. You can check a bank’s profitability by looking at its return on assets (ROA) and return on equity (ROE) ratios, which measure how much income a bank earns relative to its assets and equity. A low or negative ROA or ROE indicates a low or negative profitability. You can find these ratios in a bank’s quarterly or annual reports, or on the FDIC website.
2. Low capital adequacy ratio
A bank’s capital is the cushion that it has to absorb losses and protect depositors. When a bank’s capital falls below the minimum required level, it may mean that the bank is undercapitalized or insolvent. The capital adequacy ratio (CAR) measures how much capital a bank has relative to its risk-weighted assets, which are the assets that carry credit risk. A low CAR indicates a low capital adequacy. You can find a bank’s CAR in its quarterly or annual reports, or on the FDIC website.
3. High levels of non-performing loans
A bank’s loans are its main source of income and assets. When a bank’s loans become delinquent or default, it may mean that the bank is facing credit risk or liquidity risk. Non-performing loans (NPLs) are loans that are past due for 90 days or more, or that are no longer accruing interest. The NPL ratio measures how much of a bank’s loans are non-performing relative to its total loans. A high NPL ratio indicates a high level of non-performing loans. You can find a bank’s NPL ratio in its quarterly or annual reports, or on the FDIC website.
4. Management issues
A bank’s management is responsible for making strategic decisions, overseeing operations, ensuring compliance, and maintaining customer satisfaction. When a bank’s management is ineffective, unethical, or unstable, it may mean that the bank is poorly governed or supervised. Management issues can include frequent changes in leadership, scandals, lawsuits, regulatory actions, customer complaints, or employee turnover. You can find information about a bank’s management in its quarterly or annual reports, press releases, news articles, customer reviews, or regulatory websites.
5. Red flags in publicly available resources for monitoring bank health
Besides looking at a bank’s financial statements and ratios, you can also use some publicly available resources to monitor a bank’s health and performance. Some of these resources are:
- MyBankTracker: This website provides ratings and reviews of banks and credit unions based on their financial health, fees, customer ratings, locations, and mobile banking features. It also calculates and displays the Texas Ratio of each institution, which is a measure of credit risk that compares non-performing assets and loans to equity capital and loan loss reserves. A high Texas Ratio indicates a higher risk of failure.
- Bankrate: This website provides ratings and reviews of banks and credit unions based on their financial health, fees, customer service, product offerings, and online experience. It also provides information on deposit rates, loan rates, calculators, tools, and articles on various banking topics.
- BauerFinancial: This website provides ratings and reports of banks and credit unions based on their financial strength and stability. It also provides information on deposit rates, failed banks, troubled banks, mergers and acquisitions, and industry trends.
- FDIC: The Federal Deposit Insurance Corporation provides various data and statistics on banks and bank failures. It also provides tools and resources for consumers to check if their deposits are insured, find out if their bank is healthy, file a complaint against their bank, or get help if their bank fails.
Depositor Protection Measures
One of the main ways to protect yourself from a failing bank is to make sure your deposits are insured by the FDIC or a similar agency in your country. Deposit insurance programs are designed to protect depositors from losing their money in case their bank fails. Here are some of the features and limitations of deposit insurance programs:
- Deposit insurance programs cover deposits up to a certain limit per depositor per insured institution. You can find the deposit insurance limits in different countries on the websites of the relevant agencies or on the IMF's Deposit Insurance Database.
- Deposit insurance programs cover certain types of deposits but do not cover other types of financial products, such as stocks, bonds, mutual funds, annuities, life insurance policies, or safe deposit boxes. Safe deposit boxes are containers that customers can rent from a bank to store valuables or documents. They are not insured by the FDIC or any other agency, and they may be subject to loss or damage in case of a bank failure.
- Deposit insurance programs are funded by premiums paid by the insured institutions or by government funds. The insurance fund is the pool of money that is used to pay depositors in case of a bank failure. The fund may be managed by a government agency, a private entity, or a combination of both.
- Deposit insurance programs have different methods and procedures for resolving failed banks and paying depositors. Some programs use a payoff method, which means that they close the failed bank and pay depositors directly up to the insured limit. Other programs use a purchase and assumption method, which means that they sell the failed bank or its assets and liabilities to another institution, and transfer the deposits to the acquiring institution. Some programs may also use other methods, such as bridge banks, open bank assistance, or liquidation.
Three Strategies for maximizing deposit insurance coverage
- Spread your deposits across different insured institutions.
- Use different account ownership categories at the same insured institution.
- Use certain types of accounts that have special rules or exemptions for deposit insurance purposes. For example, some accounts that are held in trust for beneficiaries or that are linked to certain types of employee benefit plans may have higher or unlimited coverage limits.
Examples of account ownership categories:
- Single accounts: Accounts owned by one person and titled in that person's name only. They are insured up to $250,000 per owner per insured bank.
- Joint accounts: Accounts owned by two or more people and titled in their names only. They are insured up to $250,000 per owner per insured bank.
- Retirement accounts: Accounts held for retirement purposes, such as individual retirement accounts (IRAs), 401(k) plans, Keogh plans, etc. They are insured up to $250,000 per owner per insured bank.
- Trust accounts: Accounts held in trust for one or more beneficiaries by a trustee. The insurance coverage for trust accounts depends on the number and relationship of beneficiaries and whether the trust is revocable or irrevocable.
- Business accounts: Accounts owned by a business entity, such as a corporation, partnership, sole proprietorship, etc. They are insured up to $250,000 per business entity per insured bank.
FDIC insurance covers traditional deposit accounts (checking, savings, money market deposit accounts, and CDs). Please note that investment products (stocks, bonds, mutual funds, annuities, life insurance policies, etc.) are not covered by the FDIC. These products are not FDIC insured, not Bank guaranteed and may lose value.
If your deposit account balances exceed the standard insurance amount ($250,000 per depositor, per insured bank, for each ownership category), consider a combination of different account ownership categories. The most common account ownership categories are single accounts, joint accounts, and revocable trusts.
Examples to maximize your coverage:
1. Maximizing Insurance Coverage for Two Users
2. Maximizing Insurance Coverage of a Household with Two Parents and Two Children
*Payable-on-death ("POD") or in-trust-for ("ITF") – on informal revocable trust accounts, one or more named beneficiaries may be assigned to the account. The permissible beneficiaries include a natural person and a valid charity or non-profit under the IRS rules.
Diversifying Your Assets
Another way to protect yourself from a failing bank is to diversify your assets across different types of investments with low correlation to banks. Some of these investments include government bonds, gold, real estate, and stocks. Balancing risk and return in your investment portfolio is crucial, and you should consider your risk tolerance, time horizon, and financial goals when diversifying your assets.
There are several types of asset allocation strategies, such as strategic asset allocation, dynamic asset allocation, tactical asset allocation, and core-satellite asset allocation. Each strategy caters to different investment goals, risk tolerances, time frames, and diversification preferences.
To learn more about these topics, check out the following articles:
- A Modern Guide to Portfolio Diversification
- Portfolio Rebalancing
- Non-correlated Assets
- How to add Real Estate to your Portfolio
- Tactical Investing and Strategic Asset Allocation
Keeping Yourself Informed
A third way to protect yourself from a failing bank is to keep yourself informed about your bank’s financial health and performance, as well as the industry news and trends that may affect it. By staying updated, you can spot any signs of trouble early and take appropriate actions to safeguard your assets.
Some of the ways to keep yourself informed are:
- Regularly monitoring your bank’s financial health: You can use the resources mentioned earlier, such as MyBankTracker, Bankrate, BauerFinancial, or FDIC, to check your bank’s ratings, ratios, reports, and statistics. You can also review your bank’s quarterly or annual reports, which provide detailed information on its financial condition, operations, risks, and outlook.
- Staying updated on industry news and trends: You can follow reputable sources of financial news and analysis, such as The Wall Street Journal, Bloomberg, CNBC, Forbes, etc., to learn about the latest developments and events in the banking industry. You can also subscribe to newsletters or podcasts that focus on banking topics, such as American Banker, Banking Exchange, Bankrate Watchdog Report, etc.
- Developing a relationship with your bank’s staff and management: You can contact your bank’s customer service representatives or branch managers if you have any questions or concerns about your account or your bank’s performance. You can also attend any shareholder meetings or webinars that your bank may host to communicate with its customers or investors.
Preparing for a Potential Bank Failure
A fourth way to protect yourself from a failing bank is to prepare for a potential bank failure in advance. By having an emergency financial plan, you can minimize the impact of a bank failure on your financial situation and goals.
Some of the steps to prepare for a potential bank failure are:
- Developing an emergency financial plan: You should have a written plan that outlines your financial goals, current situation, budget, income sources, expenses, debts, savings, investments, insurance policies, and emergency contacts. You should also have a list of actions to take in case of a financial emergency, such as contacting your creditors, applying for assistance, or seeking alternative income sources.
- Maintaining sufficient liquidity for immediate needs: You should have enough cash or liquid assets to cover your essential expenses for at least three to six months in case of a financial emergency or a bank failure. You can keep some cash at home in a safe place or in a bank account that is easily accessible. You can also use money market accounts, short-term CDs, or Treasury bills as liquid assets that can be converted into cash quickly and with minimal loss of value.
- Being cautious about using uninsured banking products: You should avoid using banking products that are not insured by the FDIC or a similar agency, such as stocks, bonds, mutual funds, annuities, life insurance policies, or safe deposit boxes. These products are not protected from bank failures and may be subject to loss or damage. If you do use these products, you should understand the risks involved and diversify your holdings across different institutions.
What to Do If Your Bank Fails
A fifth way to protect yourself from a failing bank is to know what to do if your bank fails. By understanding the bank resolution process and cooperating with the regulatory authorities and deposit insurance agencies, you can recover your assets and find a new banking partner.
Some of the steps to take if your bank fails are:
- Understanding the bank resolution process: When a bank fails, the FDIC or a similar agency steps in to resolve it by either selling it to another institution or liquidating its assets. The resolution process may take several days or weeks depending on the size and complexity of the failed bank. During this time, you may experience some disruptions or delays in accessing your funds or services. However, you should not panic or withdraw your money unnecessarily, as this may worsen the situation and cause more problems for yourself and others.
- Cooperating with regulatory authorities and deposit insurance agencies: You should follow the instructions and guidance provided by the FDIC or a similar agency regarding your account status, deposit insurance coverage, claim procedures, and transfer options. You should also provide any information or documents that they may request to verify your identity and ownership of your deposits. You should avoid giving out any personal or financial information to anyone who claims to be a government agent or an employee of the failed bank without verifying their identity and authority.
- Recovering your assets and finding a new banking partner: Depending on the resolution method used by the FDIC or a similar agency, you may be able to recover your assets in different ways. If your bank is sold to another institution, your deposits will be transferred to the acquiring institution and you will become its customer. You can continue to use your existing checks, debit cards, and online banking until you receive new ones from the acquiring institution. You can also choose to move your deposits to another institution if you prefer. If your bank is liquidated by the FDIC or a similar agency, your insured deposits will be paid directly to you by check or electronic transfer up to the insured limit. You can then deposit your money in another institution of your choice. If you have uninsured deposits that exceed the insured limit, you may receive a portion of them from the proceeds of the liquidation after all creditors are paid.
- Accessing money after a bank failure: You should be able to access your money within a few days after a bank failure if your deposits are insured by the FDIC or a similar agency. However, if you need money urgently for essential expenses, you may consider using alternative sources of funds, such as credit cards, personal loans, family or friends, emergency savings, etc. You should also keep track of your transactions and balances during this time and report any errors or discrepancies to the FDIC or a similar agency as soon as possible.
- Keeping cash on hand and having alternative payment methods: You should keep some cash on hand in case of emergencies or disruptions in banking services due to a bank failure. However, you should not keep too much cash at home as it may be unsafe or subject to theft or loss. You should also have alternative payment methods available in case you cannot use your checks, debit cards, or online banking due to a bank failure. You should have alternative payment methods available, such as credit cards, prepaid cards, digital wallets, mobile payments, cryptocurrencies, etc. These payment methods can help you make purchases online or offline without relying on your bank account.
Protecting yourself from a failing bank is a vital part of personal financial management. By following the steps outlined in this article, you can minimize the risk and impact of a bank failure on your financial well-being and goals.
To recap, the steps are:
- Understanding bank failures and their causes, effects, and regulatory interventions
- Spotting the early warning signs of a failing bank and using publicly available resources to monitor bank health
- Maximizing deposit insurance coverage and using different account ownership categories
- Diversifying your assets across different types of investments that have low correlation to banks
- Balancing risk and return in your investment portfolio and using different asset allocation strategies
- Keeping yourself informed about your bank’s financial health and performance and the industry news and trends
- Preparing for a potential bank failure by developing an emergency financial plan, maintaining sufficient liquidity, and being cautious about using uninsured banking products
- Knowing what to do if your bank fails by understanding the bank resolution process, cooperating with regulatory authorities and deposit insurance agencies, recovering your assets, accessing money, keeping cash on hand, and having alternative payment methods
By taking these proactive steps, you can safeguard your financial assets and prepare for any financial emergencies or disasters that may arise.
If you want to learn more about bank failures and deposit insurance, here are some resources that you can check out:
- When a Bank Fails - Facts for Depositors, Creditors, and Borrowers
- FDIC: Failed Bank List
- FDIC: Deposit Insurance FAQs
- FSCS: What we cover
- IMF: Deposit Insurance Database
- MyBankTracker: Bank Health Ratings & Texas Ratio
- Bankrate: Safe & Sound Ratings
- BauerFinancial: Star Ratings
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