What is Bank Failure
A bank failure is the closing of an insolvent bank by a federal or state regulator. The comptroller of the currency has the power to close national banks; banking commissioners in the respective states close state-chartered banks. Banks close 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.
BREAKING DOWN Bank Failure
A bank fails when it can’t meet its financial obligations to creditors and depositors. This could occur because the bank in question has become insolvent, or because it no longer has enough liquid assets to fulfill its payment obligations. 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, or obligations to creditors and depositors. This might happen because the bank loses too much on its investments, especially if it loses a large amount in one area. 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 them from the bank. In recent times, the FDIC has taken over failing banks in the U.S. in order to ensure that depositors maintain access to their funds, and prevent a bank panic.
Since the creation of the FDIC, the federal government has insured bank deposits in the U.S. up to $250,000. When a bank fails, the FDIC takes the reins, and will either sell the failed bank to another, more solvent bank, or take over the operation of the bank itself. Ideally, 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. When the failed bank is sold to another bank, they automatically become customers of that bank, and may receive new checks and debit cards.
The Great Depression and the Creation of the FDIC
The FDIC was created in 1933 by the Banking Act. In the years immediately prior, which marked the beginning of the Great Depression, one-third of American banks had failed. During the 1920s, before the Black Tuesday crash of 1929, an average of about 70 banks had failed each year nationwide. During the first 10 months of the Great Depression, 744 banks failed, and during 1933 alone, about 4,000 American banks failed. By the time the FDIC was created, American depositors had lost $140 billion due to bank failures, and without federal deposit insurance protecting these deposits, bank customers had no way of getting their money back.
Recent Bank Failures
During the financial crisis that started in 2007, the biggest bank failure in U.S. history occurred when Washington Mutual, with $307 billion in assets, closed its doors. Another large bank failure had occurred just a few months earlier, when IndyMac was seized. The second all-time largest closure was $40 billion Continental Illinois in 1984. Banks continue to fail regularly. The FDIC maintains a list of failed banks on its website.