What Is a Bank Failure?
A bank failure is the closing of a bank by a federal or state regulator when the bank can't meet its obligations to depositors, borrowers, and others. The federal government has the power to close national banks and banking commissioners have the power to close state-chartered banks.
When a bank fails, the Federal Deposit Insurance Corporation (FDIC) covers the insured portion of a depositor's balance. At credit unions, the National Credit Union Administration (NCUA) insures depositors' money 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 customers, while the NCUA protects credit union customers, up to $250,000 per customer.
- In some cases, the FDIC may fully reimburse for lost deposits of a failed bank without using federal or state tax revenues.
- Bank failures are often difficult to predict. A few examples of bank failures include Washington Mutual and Silicon Valley Bank.
Understanding Bank Failures
A bank fails when it can’t meet its financial obligations to creditors and depositors. This could occur because the bank has become insolvent or no longer has enough liquid assets to fulfill its payment obligations.
The most common cause of bank failure is when the value of the bank’s assets falls below the market value of the bank’s liabilities, which are the bank's obligations to creditors and depositors. This might happen because the bank loses too much on its investments. It’s not always possible to predict when a bank will fail.
What Happens When a Bank Fails?
When a bank fails, it may try to borrow money from other solvent banks to pay its depositors. If the failing bank cannot pay its depositors, a bank panicmight ensue, causing depositors to withdraw their money from the bank (known as a bank run). This can make the situation worse for the failing bank by shrinking its liquid assets. When a bank's assets decrease, it has less money to lend to borrowers.
Since the creation of the FDIC, the U.S. government has insured bank deposits up to $250,000 per depositor per bank. When a bank fails, the FDIC takes control and will either sell the failed bank to a more solvent bank or take over the operation of the bank.
In many cases, depositors who have money in the failed bank will experience no change in their experience of using the bank. They’ll still have access to their money and should be able to use their debit cards and checks like normal.
In the event that a failed bank is sold to another bank, account holders automatically become customers of that bank and may receive new checks and debit cards.
Examples of Bank Failures
During the 2008 financial crisis, the biggest bank failure in U.S. history occurred with the closure of Washington Mutual (WaMu), which had $307 billion in assets. Washington Mutual struggled for several reasons, including a poor housing market and a run on deposits. JP Morgan Chase eventually bought WaMu for $1.9 billion. JP Morgan Chase took on another failed bank in May 2023 when the FDIC sold it First Republic Bank.
The second-largest bank failure in the U.S. was the closure of Silicon Valley Bank in 2023 after a bank run in which customers had withdrawn $42 billion within 48 hours (the bank had $209 billion in assets in December 2022).
Bank failures were common leading up to and during the Great Depression when thousands of banks failed. By the time the FDIC was created in 1933, American depositors had lost a substantial amount of money due to bank failures. Without federal deposit insurance protecting these deposits, they had no way of getting their money back.
Protections Against Bank Failures
The Federal Reserve now usually requires banks to keep a certain amount of cash reserves on hand to try to reduce the risk of failure. The reserve amount is a portion of the deposits it holds. Typically a bank must hold over 10% of its liabilities in cash reserves, but this requirement was suspended in 2020 amid the COVID-19 pandemic and was not reinstated for 2024.
The FDIC may sometimes provide reimbursem*nt beyond its coverage limits. For example, it used funds from the Deposit Insurance Fund to fully reimburse depositors when Silicon Valley Bank failed in 2023. The money in the fund is furnished by quarterly fees charged to banks, not from tax revenue.
To better protect yourself against losing money if a bank fails, consider keeping only up to the FDIC- or NCUA-insured limit, or $250,000, in one bank or credit union. If you need to deposit more funds, you can open another account at a different bank for the same FDIC protection.
Financial institutions called bad banks can also help protect failing banks. Bad banks will buy the illiquid assets and bad loans from the failing entity.
What Happens During a Bank Failure?
When a bank fails, the FDIC is required to use the least costly solution to resolve the failure. It will often sell the bank's assets to another bank. The FDIC will reimburse depositors for up to $250,000 per depositor, per institution, and in some cases, it may fully reimburse lost funds.
What Was the Biggest Bank Failure?
The biggest U.S. bank failure was the collapse of Washington Mutual (WaMu) in 2008. At the time, it had about $307 billion in assets. That bank failure was caused by several factors, including a poor housing market and a run on deposits in which customers withdrew $16.7 billion within two weeks.
When Was the Last Bank Failure?
In 2023, there were five bank failures: 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 2023. To find the last bank failure, check the FDIC's Failed Bank List, which includes banks that have failed since October 2000.
The Bottom Line
While bank failures are no longer as common as they were during the years leading up to and into the Great Depression, they can still occur. Even as banks have regulations for how much cash reserves they must have on hand and with FDIC and NCUA insurance protecting an amount of the deposits, bank failures still happen. Any number of factors, from a sudden run on deposits to changing economic conditions, can trigger a bank failure. If you're worried about a bank failure, you can work with a financial advisor to learn how to protect your funds.
