Bank failures don’t happen often. But when they do, it creates waves of concern that ripple throughout the economy. Too many bank failures clustered together can wreak havoc on consumer confidence, which can affect everything from the stock market to retail stores.
In 2023, the U.S. saw four banks fail, with three midsize or smaller banks shuttering within five days of each other in March.
The failures of Silicon Valley Bank, Signature Bank, First Republic Bank, and Heartland Tri-State Bank may have you wondering how to recognize the early warning signs of a failing bank and what happens behind the scenes when a bank fails.
Early Warning Signs of a Failing Bank
When a bank is beginning to fail, it may not be heavily reported or even common knowledge. That’s because bank officers are generally careful to keep an impending failure out of the news media. But if you read the institution’s financial statements, you may spot the warning signs.
- Declining profits. Banks make money when they invest depositors’ money at a higher interest rate than they pay out. The bank also makes money on interest collected from loans and things like service fees. Declining profits can be a telltale sign a bank is headed for collapse.
- Increasing loan defaults. Interest from loans represents a large revenue stream for banks. So many loan defaults in a short period means decreased profits, which can lead to a bank’s demise.
- Poor management practices. Typically, there’s something behind falling profitability — and that’s usually poor management. Whether the bank is making poor investment choices or spending too much, poor management can lead to bank failure.
What Happens to Depositors of a Failed Bank
If your bank fails, it’s not like your favorite store or restaurant going out of business. It’s a much bigger deal than losing any loyalty rewards you might have accrued.
Banks are responsible for millions — sometimes billions — of dollars in assets. Fortunately, if the bank folds, those assets don’t vanish like they did for millions during the Great Depression.
The U.S. government now has protections in place through the Federal Deposit Insurance Corporation to ensure depositors can access their money when a bank fails. Bank deposits are covered by FDIC insurance, up to $250,000 per account holder per account type within each financial institution.
If your bank fails, the FDIC may establish a “bridge bank,” which is an entity allowing the FDIC to run the bank until it finds a buyer or winds down the businesses methodically. That allows depositors to withdraw their funds just as they normally would.
Alternatively, the FDIC can transfer the remaining assets of the failed bank to another FDIC-insured bank. Customers receive accounts at the new bank and continue depositing and withdrawing money as usual.
What Happens to Borrowers of a Failed Bank
If you have debt like a mortgage, car loan, or personal loan with a failed bank, you are still responsible for making timely payments on the loan. Either the failed bank or the FDIC will sell your loan to another bank. The new bank will notify you in writing at least 30 days before your next payment due date.
Your interest rate and loan terms should remain the same with the new bank, but how you pay the loan might change.
A bank failure isn’t the borrower’s fault, but the new loan will show up as a new account on your credit report. That could mean a slight temporary reduction in your credit score since new credit represents a greater risk than an existing account.
Continue making on-time payments to the new lender, and your credit score should rise again. If you notice your credit score dropped significantly, check to ensure the new lender has received your payments. If they haven’t, straighten out the situation immediately to improve your credit rating.
What Happens to the Bank’s Shareholders & Employees
When a bank fails, customer deposits are protected by FDIC insurance. But shareholders don’t have the same protection for their investments. As is the case when any company folds, the bank’s stock will lose all its value.
If the FDIC has created a bridge bank to help smooth the transition, employees might stay onboard serving in their current roles, at least temporarily. The FDIC pays their salary and benefits. If another financial institution acquires the failed bank’s assets immediately, it might lay off employees or choose to keep them.
Depending on what happens to the employees of a failed bank and its size, the local economies where branches were may suffer. It’s hard for a community to rebound from job loss of any magnitude.
Additionally, corporate headquarters and bank branches may lie vacant until the buildings sell or rent. Vacant buildings bode poorly for an area’s property values and desirability.
Multiple bank failures in a short time may signal economic distress and could affect investments like the stock market as well as consumer confidence, which could negatively impact the economy and spark a recession.
Protecting Yourself From Bank Failure
Banks didn’t stop failing after the Great Depression. Our country just (mostly) got smarter about managing risk. There was a period around 2008 when a lot more banks were failing thanks to gaps in our risk management that allowed the Great Recession.
But there are still steps you need to take to take advantage of government protections and insulate your finances from serious financial shifts.
- Use an FDIC- or NCUA-insured institution. Banks are insured by the FDIC. Federal and some state credit unions are insured by the NCUA. Many neobanks are backed by insured institutions, even if they’re not themselves a qualifying bank. In fact, some neobanks diversify your deposits across multiple FDIC-insured banks, offering protection up to $2 million or more per depositor.
- Don’t exceed deposit insurance limits. It’s not enough for the place to be insured. You can’t exceed deposit insurance limits, either. Assuming the institution has insurance, most limit insured funds to one account type per person up to $250,000 (double that for joint accounts).
- Diversify your risk. Keeping all your money insured may mean having multiple account types at multiple banks to ensure every dollar is covered. You can even do that if you’re in no danger of going over the insurance limit and just want to ensure you have access to at least some money, even if one of your banks goes under.
- Research your bank’s stability. Research your bank’s credit ratings with Moody’s, Fitch, and Standard & Poor’s. The FDIC also publishes bank ratings based on the CAMELS system, which evaluates six key factors to gauge a bank’s stability: capital adequacy, assets and asset quality, management capability, earnings, liquidity, and sensitivity. If a bank scores highly in all these areas, it is likely to be stable for the long term.
- Don’t panic. If you hear rumors or bad news, no matter how reputable the source, don’t make a rash decision. Everyone pulling out their money at once can cause a bank run, which can act like a self-fulfilling prophecy. Instead, try to find out what’s really happening and consult a financial advisor if necessary.
And if the worst happens, know what to do if your bank fails.
The government classifies the U.S.’s biggest banks as “too big to fail,” meaning their demise would cause significant economic damage. These currently include JPMorgan Chase, Bank of America, Wells Fargo, and Citi. While they provide financial security, they don’t always offer low fees, high-yield savings, or the kind of service you often find at neobanks or credit unions.
By researching bank ratings, following current news, and verifying FDIC insurance coverage, you can choose a bank that exhibits financial stability while providing the benefits, rewards, and low fees you want.