What Is a Bank Failure? Definition, Causes, Results, and Examples

What Is Bank Failure?

A bank failure is the closing of an insolvent bank by a federal or state regulator. The federal government has the power to close national banks and banking commissioners have the power to close state-chartered banks.

Banks can be closed when they are unable to meet their obligations to depositors and others. When a bank fails, the Federal Deposit Insurance Corporation (FDIC) covers the insured portion of a depositor's balance, including money in money market accounts.

Understanding Bank Failures

A bank fails when it can’t meet its financial obligations to creditors and depositors. This could occur because the bank has become insolvent or because it no longer has enough liquid assets to fulfill its payment obligations.

Key Takeaways

  • Bank failures occur when the bank cannot meet its obligations to creditors and depositors.
  • The Federal Deposit Insurance Corp. (FDIC) protects deposits for up to $250,000 per depositor, per account.
  • In some cases, the FDIC may fully reimburse for lost deposits of a failed bank without using federal or state tax revenues.
  • Bank failures are often difficult to predict.

The most common cause of bank failure occurs when the value of the bank’s assets falls to below the market value of the bank’s liabilities, which are the bank's obligations to creditors and depositors. This might happen because the bank loses too much on its investments. It’s not always possible to predict when a bank will fail.

What Happens When a Bank Fails?

When a bank fails, it may try to borrow money from other solvent banks in order to pay its depositors. If the failing bank cannot pay its depositors, a bank panic might ensue in which depositors run on the bank in an attempt to get their money back. This can make the situation worse for the failing bank, by shrinking its liquid assets as depositors withdraw cash.

Since the creation of the FDIC, the federal government has insured bank deposits up to $250,000 in the U.S. When a bank fails, the FDIC takes control and will either sell the failed bank to a more solvent bank or take over the operation of the bank.

In many cases, depositors who have money in the failed bank will experience no change in their experience of using the bank. They’ll still have access to their money and should be able to use their debit cards and checks as normal.

In the event that a failed bank is sold to another bank, account holders automatically become customers of that bank and may receive new checks and debit cards.

Examples of Bank Failures

During the 2008 financial crisis, the biggest bank failure in U.S. history occurred with the closure of Washington Mutual (WaMu), which had $307 billion in assets. Washington Mutual struggled for several reasons, including a poor housing market and a run on deposits. WaMu was eventually bought by JPMorgan Chase for $1.9 billion.

The second-largest bank failure in the U.S. was the closure of Silicon Valley Bank in 2023 after a bank run in which customers had withdrawn $42 million within 48 hours. The bank had $209 million in assets at the time.

Bank failures were common leading up and into the Great Depression, when thousands of banks failed. By the time the FDIC was created in 1933, American depositors had lost a substantial amount of money due to bank failures. Without federal deposit insurance protecting these deposits, they had no way of getting their money back.

Protections Against Bank Failures

The Federal Reserve now usually requires banks to keep a certain amount of cash reserves on hand to try to reduce the risk of failure. The reserve amount is a portion of the deposits it holds. Typically a bank must hold over 10% of its liabilities in cash reserves, but this requirement was suspended in 2020 amid the COVID-19 pandemic and it had yet to be reinstated as of March 2023.

The FDIC may sometimes provide reimbursement beyond its coverage limits. For example, it used funds from the Deposit Insurance Fund to fully reimburse depositors when Silicon Valley Bank failed in 2023. The money in the fund is furnished by quarterly fees assed on banks, not from tax revenue.

To better protect yourself against losing money if a bank fails, consider keeping only up to the FDIC insured limit, or $250,000, in a bank account. If you need to deposit more funds, you can open another account at a different bank for the same FDIC protection.

What Happens During a Bank Failure?

When a bank fails, the FDIC is required to use the least costly solution to resolve the failure. It will often sell the bank's assets to another bank. The FDIC will reimburse depositors for up to $250,000 per account, per institution and in some cases it may fully reimburse lost funds.

What Was the Biggest Bank Failure?

The biggest U.S. bank failure was the collapse of Washington Mutual (WaMu) in 2008. At the time, it had about $310 billion in assets. The bank failure was caused by a number of factors, including a poor housing market and a run on deposits in which customers withdrew $16.7 billion withing two weeks.

When Was the Last Bank Failure?

The failure of the Silicon Valley Bank in March 2023 was among the most recent bank failures. To find the last bank failure, check the FDIC's Failed Bank List, which includes banks that have failed since Oct. 1, 2000.

The Bottom Line

While bank failures are no longer as common as they were during the years leading up and into the Great Depression, they can still occur. Even as banks have regulations for how much cash reserves they must have on hand and with FDIC insurance protecting an amount of the deposits, bank failures still happen. Any number of factors, from a sudden run on deposits to changing economic conditions, can trigger a bank failure.

Consider consulting with a financial advisor for guidance on how to best protect your funds from a bank failure.

Article Sources
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