What happens when a bank fails?

Bank failure is one of the biggest fears of many savers when they believe a recession is on the way. Banks generally fail when they become insolvent, which means they don’t have enough funds to cover total customer deposits and whatever money they owe to others.

In 2023, three regional banks failed due to runs on deposits. Silicon Valley Bank (SVB) and Signature Bank both failed in March 2023, and First Republic Bank collapsed in May 2023.

Since then, there have been two smaller bank failures: Heartland Tri-State Bank, headquartered in Kansas, and Citizens Bank, headquartered in Iowa (not to be confused with the larger, regional Citizens Bank). Both banks were successfully acquired.

When SVB and Signature Bank failed, the Federal Deposit Insurance Corp. (FDIC) made the unprecedented move of covering insured and uninsured deposits. Typically, though, customers of federally insured banks that fail are able to recover their funds up to the insured limit. Here we’ll take a closer look at what happens when a bank fails.

What happens in a bank failure

The FDIC is the independent regulatory agency of the federal government that oversees banking in the United States. Deposit accounts offered by banks that are members of the FDIC receive FDIC insurance coverage.

The standard FDIC deposit insurance coverage limit is $250,000 per depositor, per FDIC bank, per ownership category. This means each depositor is insured to at least $250,000 at an FDIC-insured bank.

Failed banks are listed as such when the FDIC or a state regulatory agency closes a bank. Once this happens, the assets of the bank are received by the agency — often the FDIC — and the debts resolved.

Usually, though, the FDIC doesn’t actually want to keep and manage the bank, according to Kirk Meyer, a Registered Financial Consultant and former bank examiner with the FDIC.

“When an institution fails, it will generally be announced on a Friday evening, when the regulators take over the institution and work to either sell it or dissolve it,” Meyer says. “If sold, the buying institution will be announced and a process for the transition will be developed.”

On the other hand, if the bank is dissolved, the FDIC becomes responsible for liquidating the institution. The FDIC will settle debts and claims for deposits that exceed the insurance limit.

What happens to your money when a bank closes down

What happens when your bank fails generally depends on whether the money is insured or not. There’s a good chance your bank is insured by the FDIC, according to Jim Pendergast, senior vice president at altLINE by The Southern Bank.

“In theory, your money is safe,” Pendergast says. “But that’s a bit like saying your house is safe during an inferno if you have fire coverage. It’s not a stress-free process to go through.”

The main cause for worry during a bank failure would be if the total of your deposits exceeds the FDIC coverage limit. If the amount of your deposits is greater than what’s covered, any additional amount isn’t insured. Here’s what happens in each case:

• Insured: If your deposits at the institution are under the FDIC insurance coverage limit, you can expect full reimbursement with money paid from regulatory funding.
• Not insured: For amounts above the coverage limit, things are a little dicier, according to Meyer. If bank ownership is transferred to a healthier bank, there’s a good chance that nothing will be lost. However, if it isn’t, you might have to file a claim for the excess funds. You’ll only receive reimbursement if there is money left over after the assets are sold.

The bottom line is if your money is kept with an FDIC-insured bank, you’ll at least be guaranteed up to $250,000. So, even if you have more at the bank, you’ll at least get reimbursed up to that limit. Then, you can see about getting the remainder later on.

The FDIC states that it aims to return your insurance money within two business days of the bank failing.

The National Credit Union Association (NCUA) provides a similar service for credit unions. If your money is at a credit union, it is similarly protected by the NCUA, with the same limits. This can provide peace of mind, no matter what type of institution you prefer for your money.

It’s important to note, however, that some banks and credit unions have accounts that aren’t covered by FDIC or NCUA insurance. If you have a brokerage account through your bank, that money will be covered by the Securities Investor Protection Corporation (SIPC). The SIPC covers up to $500,000 of the securities and cash held in your brokerage account.

Make sure to understand which accounts are covered by which type of insurance in the event of a failure so you know how much you’re entitled to, as well as where the guarantee is coming from.

What causes bank failures

The FDIC was created in 1933, in response to the bank failures of the Great Depression. Banks actually pay insurance premiums to receive this coverage, Registered Financial Consultant Meyer explains, so no taxpayer funds are involved.

Bank failures come about mainly because the institutions involved are unable to meet the obligations they have, which can be to depositors or other institutions. However, there are different triggers that can result in this inability to maintain solvency.

“If a bank assumes too much risk in its investments or loan portfolio and realizes its losses, that could be a cause of the failure,” Meyer says. “If no additional capital is raised and the losses are severe enough, the regulators will assume the institution to sell or liquidate it.”

The fact that banks fund their own insurance policies means that if the bank has taken on more risk than it can handle, taxpayers aren’t on the hook for the losses. Basically, when you receive reimbursement for your money up to the limit, you don’t have to worry about being paid back with your own money in the form of taxes.

Bottom line

For the most part, if you keep your money at an institution that’s FDIC-insured, your money is safe — at least up to $250,000 in accounts at the failing institution. You’re guaranteed that $250,000, and if the bank is acquired, even amounts over the limit may be smoothly transferred to the new bank.

If your bank fails and you have more money deposited than the insured limit, you can still at least file a claim with the FDIC asking for some of your assets to be returned to you. It means more paperwork, but you might also have a chance to recover more than the limit if there are assets left over after the liquidation.

In many cases, though, as altLINE’s Pendergast points out, the whole process is smooth and you might not have any money at risk.

“If they find a bank to take over, and things go according to plan, you may not even realize that the original bank failed,” Pendergast says. “All you’ll know is that your checks and debit account still work fine, then one day you’ll be issued new debit cards.”

– Bankrate’s René Bennett updated this article.