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What Is Bank Failure?

Chime Team • July 11, 2024

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Bank Failure

Bank failures occur when financial institutions cannot fulfill their obligations to depositors or creditors, leading to their closure by regulatory bodies.¹ Understanding bank failures can help us grasp the broader financial system’s stability and direct impact on individual depositors and the economy.

A bank can fail due to poor management, including inadequate loan underwriting, risky investments, or insufficient capital. Bank failures can also be triggered by larger economic downturns, resulting in loan defaults and rapid withdrawals of deposits, commonly known as a “bank run.”²

Bank failures date back to the earliest days of banking, with notable examples like the Panic of 1907 in the United States.³ This led to the creation of the Federal Reserve as a central bank to help prevent such crises and offer a safer, more flexible monetary and financial system.

A wave of bank failures in the 1930s led to the establishment of the Federal Deposit Insurance Corporation (FDIC) in 1933. The FDIC was created to restore trust in the American banking system by insuring deposits and overseeing financial institutions’ stability. The FDIC insures deposits up to $250,000 per depositor, per insured bank, for each account ownership category.

Since 2001, there have been 567 bank failures. During the 2008 financial crisis, there were 25 bank failures, including significant ones like Washington Mutual, which failed due to exposure to subprime mortgages., This period emphasized the importance of regulatory oversight and mechanisms like the FDIC in the United States.¹

The effects of bank failures

Understanding bank failures is relevant not only to the financial industry but also to individual depositors. To ensure your money is safe in the bank, you’ll want to choose a bank insured by the FDIC or a credit union insured by the National Credit Union Administration (NCUA). Bank failures can impact the broader economy, leading to a tightening of credit and making loans harder to obtain and more expensive for both businesses and consumers.

If your bank closes, the FDIC will take swift action to protect your funds. They will either transfer your money to another stable bank or send you a check for the insured amount. If a transfer isn’t possible, you can expect to receive a check within two business days of the bank’s closure.

On a broader scale, bank failures can erode confidence in the financial system. When a bank fails, it can trigger a domino effect. Fear can manifest itself among depositors at other financial institutions, leading to more withdrawals and additional stress on the banking system. This can result in a broader economic impact, tightening credit conditions and affecting businesses and consumers alike.

Peace of mind for depositors

While bank failures may seem alarming, they’re actually fairly rare. And even when they happen, it typically doesn’t impact the depositor. Thanks to stringent regulations and oversight by financial authorities, the banking system is designed to prevent such failures by overseeing banks’ activities, ensuring they maintain adequate capital, and managing risks appropriately.

In the unlikely event of a bank failure, the FDIC protects depositors by insuring accounts up to $250,000. This means that individuals with deposits within this limit are fully protected and will not lose their money.

The FDIC covers all types of deposits, including savings accounts, checking accounts, money market accounts, and certificates of deposit (CDs).¹ If you have over $250,000 in savings, consider spreading your money across multiple accounts or banks to ensure all your funds are insured.

Knowing the history of bank failures and how the nation has addressed them can give depositors peace of mind and make a connection between personal finance and the broader economy.

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1 Information from the Federal Deposit Insurance Corporation’s “When a Bank Fails - Facts for Depositors, Creditors, and Borrowers” as of June 28, 2024: https://www.fdic.gov/consumers/banking/facts/

2 Information from Corporate Finance Institute’s “Bank Run” as of June 28, 2024: https://corporatefinanceinstitute.com/resources/economics/bank-run/

3 Information from The American Deposit Management Company’s “A Brief History of U.S. Bank Failures” as of June 28, 2024: https://americandeposits.com/brief-history-us-bank-failures/

4 Information from Federal Reserve Education’s “History of the Federal Reserve” as of June 28, 2024: https://www.federalreserveeducation.org/about-the-fed/archive-history

5 Information from the Federal Deposit Insurance Corporation’s “Bank Failures in Brief - Summary” as of June 28, 2024: https://www.fdic.gov/resources/resolutions/bank-failures/in-brief/index.html

6 Information from the Federal Deposit Insurance Corporation’s “Bank Failures: 2008 in Brief” as of June 28, 2024: https://www.fdic.gov/resources/resolutions/bank-failures/in-brief/bfb2008.html

7 Information from the Federal Deposit Insurance Corporation’s “Status of Washington Mutual Bank Receivership” as of June 28, 2024: https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/wamu-settlement.html

8 Information from AP News’ “Banks report tougher credit standards in wake of failures” as of June 28, 2024: https://apnews.com/article/banks-federal-reserve-credit-business-recession-63267e5af0c7a8153d0c1681d15da5d5

9 Information from CNET Money's "If My Bank Fails, What Happens to My Money?" as of July 1, 2024: https://www.cnet.com/personal-finance/banking/advice/if-my-bank-fails-what-happens-to-my-money/

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