What Happens When a Bank Fails: Understanding the Consequences

Silicon Valley Bank headquarters and branch

The collapse of Silicon Valley Bank rattled the financial markets earlier this year. When a bank failure hits the headlines, it’s natural to be concerned about the funds you have stored in your bank account. While a bank failure is usually a bad sign for the economy, FDIC deposit insurance means that your funds are likely safe.  

Let’s explore how a bank failure can impact the economy, and your financial standing.  

Why do banks fail? 

Some of the most common reasons for bank failures include mismanagement, bad loans, and economic downturns.  

Signature Bank, which failed in March 2023, is the latest example of a failed bank. It was shut down after a run on deposits, which amounted to billions of dollars in withdrawals in the days following the Silicon Valley Bank failure.  

Some of the reasons for Silicon Valley’s Bank (SVB) failure included an insufficient amount of asset diversification and interest rate risk. In the years leading up to the failure, SVB had a large portion of its assets invested in fixed-income securities, which had relatively low interest rates.

When the Federal Reserve started increasing interest rates, SVB was vulnerable. As SVB customers ran into reasons to withdraw their funds, SVB had to sell fixed-income securities with low interest rates at a loss. Ultimately, this spurred the bank’s collapse.  

The 2008 failure of Washington Mutual was another high-profile bank run. Depositors withdrew $16.7 billion in deposits in just nine days. After the run, the federal government seized control of Washington Mutual and sold it to JPMorgan Chase.  

Although the exact reasons for a bank failure vary from case to case, these uncomfortable events tend to happen during uncertain financial times.  

The consequences of a bank shutdown  

A bank shutdown is never an ideal situation. While the news might surprise those watching the headlines, a bank failure is often the result of years of decisions.  

When a bank is heading for failure, it’s common for the federal government to get involved. Typically, government involvement is intended to minimize the impact of the failure on the depositors. Additionally, governments may try to limit the shockwaves sent out through the entire financial system. Without intervention, a bank failure could set off a widespread financial crisis.  

In the wake of a failure, the bank is often forced to liquidate its assets. At first, the Federal Deposit Insurance Corporation (FDIC) tends to receive the assets. But eventually, the assets are sold to repay depositors and settle debts. If the assets aren’t sufficient to cover the depositors, the FDIC provides coverage for the protected funds, up to $250,000 per depositor.  

In many cases, the economic implications aren’t confined to the particular bank. Instead, a bank failure tends to impact the entire financial system. Lost confidence in the financial system can greatly impact economic activity and lending behaviors.  

How to protect yourself against a bank failure 

If you’re concerned about the impact of a bank failure, here’s how to protect yourself.  

Choose an FDIC-Insured bank 

FDIC insurance is the banking world’s answer to the public’s fears of a banking failure. If an FDIC-insured bank fails, your funds are protected up to a certain amount ($250,000 per account holder).  

When choosing a bank, it is critical to opt for a bank with FDIC deposit insurance. Otherwise, you are putting your funds in an unnecessarily risky situation. The good news is that most banks are FDIC-insured. But it’s always a good idea to double-check this critical fact before opening a new bank account.  

Understand your FDIC coverage limits 

FDIC insurance is a useful tool to protect your hard-earned cash from the fallout of a bank failure. However, there are limitations to FDIC insurance. The limit is $250,000 per account holder, per each ownership category, per insured bank.  

As you map out your banking solutions, it’s a good idea to keep this coverage limit in mind. For example, let’s say that you have $300,000 that you want to store in a high-yield savings account.  

Based on the FDIC coverage limits, you might choose to split your funds between two high-yield savings accounts at different banks. If you tuck all those funds into a single account, a portion of your money wouldn’t be protected under the FDIC insurance coverage.  

Monitor your bank 

Take some time to review your bank’s financial health regularly. If you spot a problem, like bad investments or unreliable leadership, consider moving your funds to a different bank.  

Use multiple banks 

FDIC insurance should lead to you getting your covered funds back after a bank failure. But the reality is that you might be waiting days, weeks, or months for the situation to be resolved. If all of your funds are tied up with a failed bank, it could make for a difficult time in your household.  

You can mitigate this risk by storing funds at multiple banks. While using multiple banks can present a logistical issue, keeping a portion of your funds in separate banks can help you make it through a bank failure.  

For example, you might have a standard checking account at one bank that receives your paycheck. But it might be a good idea to open a high-yield savings account at another bank. If one of the banks goes under, you’ll still have some liquidity as you navigate a challenging time.  

Bank failures happen but you can prepare 

Bank failures seem to be an unavoidable part of the financial system. On the whole, bank failures are a relatively rare occurrence. But if you are concerned about the potential for a bank failure, you can take action to protect yourself by understanding the limits of FDIC insurance and choosing to work with FDIC-insured banks.  

Written by Sarah Sharkey | Edited by Rose Wheeler

Sarah Sharkey is a personal finance writer who enjoys diving into the details to help readers make savvy financial decisions. She lives in Florida with her husband and dogs. When she’s not writing, she’s outside exploring the coast. You can connect with her on her blog Adventurous Adulting.

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