What Happens When Banks Fail?

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During the past few years, there have been a lot of tremors in the banking industry, with many banks finding themselves on shaky ground. As consumers, how well is our money protected during a crisis that has plagued our large financial establishments and institutions?

Usually, banks fail when they are unable to pay or meet their obligations towards their customers. In the United States, almost all the banks are insured; it means that they are well governed by the rules and regulations of the Federal Deposit Insurance Corporation, also known as the FDIC. During the 80’s and 90’s, the world faced some of its biggest financial challenges when major S & L (Savings and Loans) institutions collapsed. It was then that many of us may have first become aware of the FDIC, which has the aim of safeguarding the money of bank depositors. The FDIC is a self-regulating federal agency formed to support financial liquidity and stability in the nation’s banking system.

Know what happens when a bank fails? The moment any bank declares bankruptcy, the FDIC comes into play and it immediately starts searching for possible buyers for the bank, in consultation with the central bank and the government. In the meantime, the FDIC, which has insured a sum of $250,000 per individual account, begins covering bank depositors. But what happens when there are no buyers lined up for an ailing bank? As long as there are funds in the FDIC’s coffers, then depositors can still expect full coverage up to the maximum amount of FDIC insurance per account they own. But anything beyond those limits will not be covered, so we are advised, as consumers, to deposit money in multiple accounts (perhaps across several savings accounts, CDs or high yield checking accounts) to keep our funds below those limits.

Naturally, the focus on the FDIC intensifies during difficult financial times. You can expect the FDIC to step in when a bank is in trouble. FDIC plays two major roles: it acts as an insurer to the depositors and pays up to the limit of insurance and secondly, it acts as a mentor of the bank to help it to come out of bankruptcy. FDIC pays the insured from a pool funded by insurance premiums already collected from its bank members, along with earnings made by this pool in various fixed income investments.

In principle, this practice of safe guarding the depositor’s financial interests certainly shores up our confidence in our banks, but there is always the concern that an implosion in the banking industry could result in many banks failing all at the same time. What happens then? For instance, in one previous year, the FDIC started its pool with approximately $53 billion, but by the end of the year it had fallen to just $40 billion due to the bankruptcy of 13 major banks. The Federal Reserve maintains a “troubled banks list and in it, there are 117 banks registered. Could all these banks go belly up? Well this remains to be seen, but in order to protect the banks’ depositors, the FDIC continues to increase its efforts by increasing its pool and finding new investments for their funds.