What Happens When a Bank Fails? Understanding the Impact and Consequences


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What Happens When a Bank Fails? Understanding the Impact and Consequences
What Happens When a Bank Fails? Understanding the Impact and Consequences


The collapses in March of Silicon Valley Bank (SVB) and Signature Bank – two of the largest U.S. banks to fail since the Great Depression of the 1930s – have led some to wonder if the nation may be headed for a new widespread banking crisis.

The Federal Deposit Insurance Corporation (FDIC) was established in 1933, and federal deposit insurance began on January 1, 1934. In the years following, the FDIC played a critical role in stabilizing the U.S. banking system by closing insolvent banks. The introduction of federal deposit insurance reduced the incentive for nervous depositors to withdraw their funds in a panic when a bank showed signs of distress. As a result, between 1934 and 1940, the FDIC closed an average of 50.7 banks annually.

Banks can collapse for various reasons, but most failures fit into a few key scenarios. These include a bank run, where depositors withdraw funds en masse, leaving the bank without enough cash; a significant accumulation of bad loans or a dramatic loss in the value of assets, which erodes the bank's capital; or a mismatch between what the bank earns from its assets (mainly loans) and what it pays on its liabilities (mainly deposits).

Often, bank failures involve a combination of these issues. In the case of Silicon Valley Bank (SVB), a series of events contributed to its collapse. The bank had substantial investments in government bonds, which decreased in value as the Federal Reserve aggressively raised interest rates. Concurrently, as startup funding dried up, many of SVB's customers began withdrawing their deposits. When SVB made drastic moves to stabilize its finances—like selling its entire bond portfolio at a loss of $1.8 billion and announcing plans to raise $2.25 billion through a stock offering—this triggered more panic among its depositors, accelerating the rush to withdraw. 

According to SVB's December 31 call report, about 86% of its deposits were over the then-insurance limit of $250,000, which added to depositors' anxiety.

Silicon Valley catered to tech startups and many held deposit balances well in excess of the Federal Deposit Insurance Corp.'s insured limit of $250,000. For instance, TV streaming platform Roku Inc. announced it had approximately $487 million at Silicon Valley at the time of the bank's implosion.

Since the year 2000, 568 banks have failed across the United States resulting in losses of $111,871,485,000. 

We must learn from past mistakes, if you have over $250,000 in a bank account and your bank fails, you will not be insured. 

Source: FDIC

When you deposit money in a bank, you expect it to be safe, easily accessible, and growing through interest or investments. But what happens when a bank fails? Bank failures, although rare, do happen, and they can have significant consequences for individuals, businesses, and the economy. This blog post will explore what happens when a bank fails, how it affects customers, and the steps taken to mitigate the impact.

What Does It Mean for a Bank to Fail?

A bank failure occurs when a financial institution is unable to meet its obligations to depositors, creditors, or other stakeholders. This can happen due to a variety of reasons, including poor management, insufficient capital, high-risk investments, or external economic shocks. When a bank fails, it can no longer operate as a viable business entity, leading to a disruption in its services and a potential loss of customer deposits.

What Happens When a Bank Fails?

When a bank fails, regulatory authorities and government agencies take specific steps to ensure stability and protect depositors' interests. Here's a general outline of what happens:

1. Regulatory Intervention

Bank failures are typically managed by regulatory agencies such as the Federal Deposit Insurance Corporation (FDIC) in the United States, the Financial Services Compensation Scheme (FSCS) in the United Kingdom, or similar bodies in other countries. These agencies step in to assess the situation, determine the extent of the failure, and plan for the bank's resolution.

2. Closure and Takeover

Regulators may close the bank and take over its operations. This usually involves a thorough examination of the bank's assets, liabilities, and overall financial condition. The goal is to minimize disruption to customers and the broader financial system.

3. Protecting Depositors

In many countries, deposit insurance is in place to protect customers' funds in case of a bank failure. For example, the FDIC insures deposits in U.S. banks up to $250,000 per depositor, per insured bank. If the bank fails, depositors are reimbursed up to the insured limit, typically within a short period.

4. Restructuring or Merging

Regulators may attempt to restructure the failed bank's assets or merge them with another financial institution. This approach helps maintain continuity for customers and reduces the negative impact on the economy.

5. Asset Liquidation

In some cases, the failed bank's assets may be liquidated to pay off creditors and other stakeholders. This can take time and may result in significant losses for some parties.

Credit: S&P Global

How Does a Bank Failure Affect Customers?

If a bank fails, customers may experience some disruption in service, but the impact on their deposits is usually minimal due to deposit insurance. Here's what customers can expect:

1. Access to Funds

If deposit insurance is in place, customers can access their insured funds quickly, often within a few days of the bank's closure. This ensures that individuals and businesses can continue their financial activities with minimal interruption.

2. Account Transfers

In cases where the failed bank is merged with another institution, customers' accounts are typically transferred to the acquiring bank. This may involve changes in account numbers, routing information, and online banking access, but efforts are made to ensure a smooth transition.

3. Reimbursement of Insured Deposits

For deposits within the insured limit, customers are reimbursed without incurring losses. However, for deposits exceeding the insured limit, there may be uncertainty and loss of funds. 

As banking industry observers wonder whether more dominoes will fall, about a third of Americans (36%) say they’re very concerned about the stability of banks and financial institutions – considerably smaller than the shares expressing that level of concern about consumer prices and housing costs – according to a recent Pew Research Center survey.

Nor can banks count on much public sympathy. More than half of Americans (56%) say banks and other financial institutions have a negative effect on the way things are going in the country these days, while 40% say they have a positive effect, according to an October 2022 Center survey. A dim view of the financial services industry, in fact, is one of the few things that unites partisans. In the same October 2022 survey, similar shares of Republicans and those who lean toward the Republican Party (59%) and Democrats and Democratic leaners (57%) said banks and financial institutions have a negative effect on the country.

So… how much money does the FDIC have? 

According to the FDIC website: "The Reserve Ratio for the Deposit Insurance Fund Declined to 1.11 Percent: The Deposit Insurance Fund (DIF) balance was $116.1 billion on March 31, 2023, down $12.1 billion from the end of fourth quarter 2022, largely reflecting provisions for actual and anticipated failures in the first quarter, including the recent failures of three institutions.  When combined with insured deposit growth of 2.5 percent over the quarter, the reserve ratio decreased 14 basis points to 1.11 percent."

This means that if there was a total US banking failure, only 1.11% of Americans would be protected by the FDIC insurance. 

Conclusion: Protecting Your Wealth in Times of Banking Uncertainty

The failure of major banks like Silicon Valley Bank (SVB) and Signature Bank has sent shockwaves through the financial world, leaving many wondering if broader banking instability is on the horizon. Although the Federal Deposit Insurance Corporation (FDIC) plays a crucial role in mitigating the impact of bank failures, it's clear that there are limits to the protection it can offer. The events of March 2022 serve as a reminder that financial crises can strike unexpectedly, causing significant disruption to depositors and the wider economy.

Given that federal deposit insurance is capped at $250,000 per depositor per bank, those with balances exceeding this limit face increased risk in the event of a bank failure. Additionally, the FDIC's reserve ratio, which has declined to 1.11 percent, indicates that only a fraction of depositors' funds would be insured in the event of a systemic banking collapse. This uncertainty has prompted many to seek alternative ways to safeguard their wealth.

One proven method to protect your assets in times of financial turmoil is to diversify into tangible assets like gold and silver. These precious metals have been recognized for centuries as a reliable store of value, particularly during periods of economic instability. Gold and silver offer a hedge against inflation, currency devaluation, and banking crises, providing you with a solid safety net when other financial instruments may falter.

By investing in gold and silver, you can reduce your exposure to the risks associated with the traditional banking system. These metals have intrinsic value and are not dependent on any single institution's stability. Furthermore, gold and silver are globally recognized and can be easily liquidated when needed, ensuring that you always have access to your wealth.

While bank failures are rare, they do happen, and the recent collapses remind us of the fragility of the financial system. To safeguard your financial future, consider diversifying your assets and exploring investments in gold and silver. This strategic approach can provide you with peace of mind and a measure of security, even in uncertain times. Start exploring your options today, and ensure that your wealth is protected against the unexpected.

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