Bank Failure: Definition, Causes, Results, and Examples

Bank Failure

A bank failure is the closing of a bank by a federal or state regulator due to its inability to meet obligations to depositors, borrowers, and others. Federal government and banking commissioners have the power to close national and state-chartered banks, respectively.

In the event of a bank failure, the Federal Deposit Insurance Corporation (FDIC) provides coverage for the insured portion of a depositor’s balance. At credit unions, depositors’ money is insured by the National Credit Union Administration (NCUA) up to $250,000 each.

Key Takeaways

• Bank failures occur when a bank cannot meet its obligations to creditors and depositors.
• The FDIC protects bank and credit union customers up to $250,000 per customer.
• In some cases, the FDIC may fully reimburse lost deposits without using federal or state tax revenues.
• Examples of bank failures include Washington Mutual and Silicon Valley Bank.

Understanding Bank Failures

A bank fails when it cannot fulfill financial obligations to creditors and depositors. This can happen when the bank becomes insolvent or lacks sufficient liquid assets to meet payment obligations.

The most common cause of bank failure is when the bank’s assets fall below the market value of its liabilities, which are its obligations to creditors and depositors. This can occur when the bank incurs significant losses on investments. Predicting bank failures is often challenging.

What Happens When a Bank Fails?

When a bank fails, it may attempt to borrow money from other solvent banks to pay depositors. If the bank fails to pay depositors, a bank run may occur, exacerbating the situation by reducing the bank’s liquid assets. Consequently, the bank will have less money available to lend to borrowers.

The FDIC, since its establishment, insures bank deposits up to $250,000 per depositor. In the event of a bank failure, the FDIC assumes control of the bank and either sells it to a more solvent bank or manages its operation.

In many cases, account holders experience no disruption in accessing their funds or using their debit cards and checks. If a failed bank is sold to another bank, account holders become customers of the acquiring bank and may receive new checks and debit cards.

Examples of Bank Failures

During the 2008 financial crisis, the largest bank failure in U.S. history was Washington Mutual (WaMu), which had $307 billion in assets. WaMu faced challenges due to a poor housing market and a bank run. It was eventually acquired by JP Morgan Chase for $1.9 billion. In May 2023, JP Morgan Chase acquired another failed bank, First Republic Bank, which was sold by the FDIC.

The second-largest bank failure in the U.S. occurred in 2023 when Silicon Valley Bank saw a bank run resulting in customer withdrawals of $42 billion within 48 hours. The bank had $209 billion in assets as of December 2022.

Bank failures were prevalent during the Great Depression, with thousands of banks failing. Prior to the creation of the FDIC, depositors lost substantial amounts of money. Federal deposit insurance provides protection against such losses.

Protections Against Bank Failures

The Federal Reserve typically requires banks to maintain cash reserves as a safeguard against failure. This reserve is a portion of the deposits the bank holds. Although banks are typically required to hold over 10% of their liabilities in cash reserves, this requirement was temporarily suspended in 2020 during the COVID-19 pandemic and has not yet been reinstated.

In certain cases, the FDIC may provide reimbursement beyond its coverage limits. For instance, when Silicon Valley Bank failed in 2023, the FDIC fully reimbursed depositors using funds from the Deposit Insurance Fund. This fund is supported by quarterly fees charged to banks, not tax revenue.

To mitigate the risk of losing funds in the event of a bank failure, consider keeping only up to the FDIC- or NCUA-insured limit of $250,000 in one bank or credit union. Additional funds can be deposited in another bank for the same level of protection.

Moreover, bad banks, specialized financial institutions, can assist in protecting failing banks by purchasing illiquid assets and bad loans.

What Happens During a Bank Failure?

During a bank failure, the FDIC is mandated to employ the least costly solution to resolve the failure. Often, the bank’s assets are sold to another bank. The FDIC reimburses depositors up to $250,000 per depositor, per institution, and in certain cases, may fully reimburse lost funds.

What Was the Biggest Bank Failure?

The largest bank failure in the U.S. happened in 2008 with the collapse of Washington Mutual (WaMu), which had approximately $307 billion in assets. Poor market conditions and a bank run led to this failure, with customers withdrawing $16.7 billion within two weeks.

When Was the Last Bank Failure?

In 2023, five bank failures occurred: Citizens Bank in November, Heartland Tri-State Bank in July, First Republic Bank in May, Signature Bank in March, and Silicon Valley Bank in March. To find the most recent bank failure, refer to the FDIC’s Failed Bank List, which includes banks that have failed since October 2000.

The Bottom Line

While bank failures are now less frequent compared to the period leading up to and during the Great Depression, they can still happen. Despite regulations and FDIC and NCUA insurance protecting deposits, bank failures can occur due to factors like sudden deposit runs or changing economic conditions. If you have concerns about a bank failure, consult a financial advisor to learn how to protect your funds.