Bank closures are not a common occurrence. However, when they do happen, they can trigger waves of concern that reverberate throughout the economy. Clusters of multiple bank closures can severely undermine consumer confidence, affecting everything from the stock market to retail stores.

In 2023, the United States experienced four bank closures, with three mid-sized or small banks collapsing within five days in March. The collapses of Silicon Valley Bank, Signature Bank, First Republic Bank, and Heartland Tri-State Bank might make you wonder how to identify early warning signs of a bank closure and what happens behind the scenes when a bank collapses.

Early Warning Signs of Bank Closure:

When a bank starts to fail, it might not be widely reported or even well-known because bank officials typically try to avoid media coverage of an impending bankruptcy. However, if you look at the institution’s financial statements, you might find warning signs.

  • Declining profits: Banks make money by investing depositors’ funds at rates higher than the rates they pay. They also earn money through loan interests and service fees. A decline in profits can be a clear sign that a bank is on the brink of collapse.
  • Increased loan default rates: Loan interests are a significant revenue source for banks. Such a high number of loan defaults in a short period might mean reduced profits, potentially leading to bank closure.
  • Poor management practices: Usually, a decrease in profitability has some underlying cause—often poor management. Whether the bank makes wrong investment choices or spends excessively, mismanagement can lead to bank closures.

What Happens to Depositors of a Bank Under Bankruptcy:

If your bank goes under, it’s not like losing your favorite store or restaurant; it’s much more severe. The bank is responsible for millions or even billions of dollars in assets. Fortunately, if a bank goes under, these assets don’t disappear, as they did for millions during the Great Depression.

The U.S. government now offers protection through the Federal Deposit Insurance Corporation (FDIC) to ensure depositors can withdraw their funds when a bank closes. Bank deposits are insured by the FDIC for up to $250,000 per account type per account holder within each financial institution.

If your bank goes under, the FDIC may establish a “bridge bank” that allows the FDIC to operate the bank until a buyer is found or wind down operations in an orderly manner. This allows depositors to withdraw funds as usual.

Alternatively, the FDIC can transfer the remaining assets of the failed bank to another FDIC-insured bank. Customers receive their accounts at the new bank and continue to deposit and withdraw funds as usual.

How Borrowers of a Bank Under Bankruptcy Are Affected:

If you have debts such as mortgages, auto loans, or personal loans at a collapsed bank, you are still responsible for timely repayment. The failed bank or the FDIC will sell your loans to another bank. The new bank will notify you in writing at least 30 days before your next payment due date.

Your rates and loan terms should remain the same with the new bank, but the way you pay the loan might change.

Bank Shareholders and Employees:

When a bank fails, client deposits are protected by FDIC insurance, but shareholders’ investments do not receive the same protection. Similar to any company’s collapse, bank stocks become worthless.

If the FDIC sets up a bridge bank to facilitate a smooth transition, employees might continue in their current roles, at least temporarily, with the FDIC paying their wages and benefits. If another financial institution immediately acquires the failed bank’s assets, it may lay off employees or choose to retain them.

Depending on the scale of the bank’s bankruptcy and the experiences of the bank’s employees, the local economy where the branch is located may be affected. It’s difficult for a community to recover from any scale of unemployment.

Moreover, both the corporate headquarters and bank branches might sit idle until the buildings are sold or leased. Vacant buildings are not a good sign for the property value and attractiveness of an area.

Multiple bank closures within a short period might signal economic troubles and could impact investments like the stock market and consumer confidence, thus negatively affecting the economy and triggering a recession.

Protecting Yourself from the Impact of Bank Failures Banks did not stop failing after the Great Depression. Our country (for the most part) became smarter in risk management. There was a period around 2008 when more banks collapsed due to our risk management flaws, leading to the Great Recession.

However, you still need to take some measures to leverage government protection and shield your finances from severe financial changes.

  • Use institutions insured by the FDIC or NCUA: Banks are insured by the FDIC, while federal and some state credit unions are insured by the NCUA. Many new banks have the backing of these insured agencies, even if they are not eligible banks themselves. In fact, some new banks spread your deposits across multiple FDIC-insured banks, offering each depositor protection of up to $2 million or more.
  • Don’t exceed the deposit insurance limit: Having insurance isn’t enough. You also can’t exceed the deposit insurance limit. Assume most insured funds are limited to $250,000 per person for each account type (double for joint accounts).
  • Diversify your risk: Insuring all your funds might mean having various account types in multiple banks to ensure every dollar is protected. You can even do this if you’re not in danger of exceeding the insurance limit and just want to make sure you have at least some money in case one of your banks goes bankrupt.
  • Research the stability of the bank: Look into Moody’s, Fitch, and Standard & Poor’s credit ratings for your bank. The FDIC also issues bank ratings based on the CAMELS system, which assesses six key factors measuring a bank’s stability: Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity. If a bank scores high in all these areas, it’s likely to be stable long-term.
  • Don’t panic: Don’t make rash decisions if you hear rumors or bad news, no matter how reputable the source. Everyone taking money out at the same time can lead to a bank run, like a self-fulfilling prophecy. Instead, try to find out what’s really going on and consult a financial advisor if necessary.
  • Know what to do if the worst happens and your bank goes under.

Closing Note: The government categorizes the largest banks in the United States as “too big to fail,” meaning their collapse would cause significant economic losses. These currently include JPMorgan Chase, Bank of America, Wells Fargo, and Citibank. While they offer financial security, they don’t always provide low-cost, high-yield savings or the services you frequently find in new banks or credit unions.

By researching bank ratings, staying updated with current events, and verifying the FDIC insurance coverage, you can choose a financially stable bank that also offers the benefits, rewards, and low fees you desire.