By Patrick Russo
A bank failure regularly occurs when a bank’s assets become less valuable than its liabilities. The value of an institution’s assets can diminish for a number of reasons, including an increase of noncurrent loans, a decrease in deposits, or a decrease in the loan loss allowance amount on its books. Some banks are able to recover before the FDIC (Federal Deposit Insurance Corporation) boards up the windows, but on many occasions the government regulatory agency quickly steps in and closes down operations in an attempt to minimize economic damages. The FDIC has closed 16 banks down so far this year, and so as not to waste an opportunity to learn from these failures, here are 25 lessons you, as a consumer, should take in stride:
Make Sure All of Your Deposits Are Always Insured
The FDIC operates an insurance fund called the Deposit Insurance Fund (DIF), which consists of premiums paid by participating institutions. This fund totaled more than $33 billion at the end of 2012, and is well on its way to a targeted reserve ratio of 1.35 percent of all deposits. In return for premiums paid, each participating bank or savings institution is able to insure each of its individual depositors up to $250,000. The FDIC may insure more than this amount depending on the depositor’s categories of legal ownership (i.e., if a depositor has a single account and a joint account, he or she could be insured for more than $250,000). With such generous coverage, there is little reason to avoid making sure that all of your deposits are always insured. If you are approaching $250,000 across multiple accounts at one bank or think interest earned could soon put you over that amount, check with your bank to see if your ownership categories qualify you for more insurance coverage. If not, you need to begin searching for another bank in order to maintain coverage on any excess amounts.
Spread Deposits Over $250,000 out across Different Banks, not Different Branches
Despite the range of branch locations (and architecture) at some of the bigger banks, don’t confuse different branches for different banks. Even if you spread $25 million out at 10 different branches belonging to the same bank, you could end up with only a fraction of this amount guaranteed by FDIC insurance limits in the event of a bank failure.
Make Sure Your Money is Not ‘Locked Up’
Even if you’ve made sure that all of your money is covered by FDIC insurance limits, if it is all in one account it could still be out of reach for a period of time when the bank fails. This period may only be a few days, but if you have bills, a family, or a business depending on your cash flow provisions, this lack of access could tangle up a few relationships.
Explore Other Account Options Like CDARS
If you have significant liquidity and don’t want to spend all of your time maintaining a large number of bank accounts (what a nice, first world problem!), a CDARS account would be a great way to go. CDARS is a service that places your funds at a variety of different institutions for you in order to take advantage of the market’s best rates and keep your funds always under the FDIC insured limits. You’ll receive consolidated interest payments from the single institution that holds your CDARS account, so it automatically simplifies this investment strategy.
Not Every Failure Means a Systemic Crisis
In the wake of the Cyprus banking default, many news outlets carried stories that magnified the threat of banking failures and depositor losses in the United States. Despite the apocalyptic forewarnings, consumers have seen no real reason for immediate anxiety over the welfare of their deposits. Despite potential long-term regulatory implications for financial institutions in the Eurozone, there is and was never an imminent threat of a domino effect across U.S. banks and credit unions. Just the same, most banking failures that start inside the United States remain very local to the affected institution and rarely have string-like implications.
Greedy Bankers Are Not Always to Blame
While the media tends to fire up the barbecue pit and look for a banker to roast after a failure (the bigger the bank, the hotter the fire), bank leadership and equity owners are not necessarily the culprits. Instead, the causes of a bank’s failure are usually complicated and not readily identifiable because of bigger market factors like shifts in housing prices or changing industry regulations. The 2008 banking collapse was a combination of regulatory error and willful ignorance at the tops of big banks.
No Size is Immune
Big and small, tall and large, wide and skinny, banks of all shapes and sizes are susceptible to failure. More assets do not necessarily mean more security when it comes to bank insolvency. Washington Mutual had over $100 billion in deposits when the FDIC brought it into receivership in 2008. On the other hand, Sunrise Bank, which failed this year, had less than $60 million in deposits.
Banks Are Usually Closed Quietly
Unlike the case of IndyMac’s bankruptcy, most bank failures happen quietly by design. The FDIC’s ideal bank closure process consists of the agency closing down the bank on a Friday, reorganizing it over the weekend, and handing it over to new ownership on Monday. After a letter was publicized from a United States Senator about the likelihood of IndyMac going bankrupt, depositors began quickly retrieving their funds. This semi-panic forced the FDIC to take over the bank instead of giving it time to recover.
Pay Attention to Bank Health Ratings and Texas Ratios
While it’s true that bank failures often come as a surprise, regularly monitoring a Bank Health Ratings and Texas Ratio list will give you a good grasp of whether a bank is thriving or surviving. As a bank’s number approaches 100%, it becomes more likely to end up insolvent, and you could end up with more of a headache tracking reassigned loans or waiting for a check from the FDIC for your deposits.
The FDIC Keeps its List of Troubled Banks “Hush-Hush”
The FDIC maintains a list of troubled banks that are at risk of becoming insolvent in the near future. This list is kept hidden from the public so as not to incite consumer panic resulting in a run on the bank. Though depositors won’t get to see how close to the brink their bank is in the government’s eyes, the above Bank Health Ratings will help give a fair idea.
Be Prepared to Lose Those Nice CD Rates
In the current low rate banking environment, any long-term, high rate CDs you have will likely evaporate should the bank fail. This loss should come as no surprise but could be untimely if you were counting on the interest of a particular CD for another year or two.
Go Look for Better Banks Once Yours Fails
If your bank does fail, and the acquiring bank’s new accounts are disappointing, use the wide array of tools on the Internet to search for better options. Internet banks are offering competitive rates, as well as credit unions, and these institutions are making it easier and easier for you to find them.
Federal and State Tax Revenues Are Not the Source of FDIC Insurance Funding
When the FDIC is forced to reach into its Deposit Insurance Fund for funds to cover the losses resulting from a failed bank, it is not reaching for tax revenues collected from citizens. As mentioned above, insured banks pay the premiums that make up most of the FDIC’s insurance fund. Additionally, the FDIC has an investment portfolio of U.S. Treasury securities, the interest earnings of which are also deposited into the fund.
Interest Accruing on Deposits Stops as Soon as the Bank is Closed
The traditional deposit accounts insured by the FDIC are checking, savings, Money Market, and Certificate of Deposit (CD) accounts. Depending on the banking institution, most of these accounts will bear recurring interest commensurate with the amount deposited by the consumer, and for term lengths determined by the type of account. After a bank fails and is closed by the FDIC, the rate of interest formerly guaranteed by the failed bank is no longer effective. The bank or financial institution acquiring the failed bank’s assets and/or loans has the choice to maintain the previous interest rates or else determine new rates. Depending on the position of the acquiring bank, those rates could be higher or lower, but the bank is under no obligation to uphold a previous rate of interest. All interest accrued up until the point of the bank closing is secured by the FDIC insurance fund up to the insurance limit.
No Buyer Means You’re Probably Going to Lose Interest
In most cases, the FDIC is able to find and arrange for another institution to purchase the assets and deposits of a failed bank. However, from time to time there is a lag between failure and acquisition that could cost you interest earnings. The “in-between” could be as long as a week or two, and that could mean significant interest depending on the size of your account.
Outstanding Checks May Be Returned
If you have written checks from your checking account to businesses or vendors that have not been cashed at the time your bank is closed due to failure, they will all be returned if the FDIC can’t find a buyer. This return is because the FDIC will send you a check for the amount of funds in your checking account at the time the bank closes and they won’t make sure all of your outstanding checks are paid.
Brokered CDs Take Longer to Transfer, If They Transfer at All
If you own a CD that was purchased through a broker rather than directly from the bank itself, it might take a while to transfer from the failed bank to the acquiring one. In many cases, the acquiring bank won’t assume the CD because they want the customer purchase one directly from them.
Depositors, by Law, Have Top Priority to a Failed Bank’s Liquidated Assets
If you are a depositor with over the FDIC insured amount in a particular bank when it fails, you are in the best position to recover all of your money. By law, insured depositors receive payments from the failed bank’s liquidated assets first, followed by uninsured depositors, general creditors, and then stockholders. If you have the opportunity to become a stockholder in a banking institution, the Bank Health Ratings list mentioned above is mandatory research before moving forward.
Loans Don’t Go Away, but Can Be Helpful Cushions
If the bank holding your loan fails, the debt doesn’t just go away, unfortunately (if only consumers had the luxury akin to a retail store when a customer loses a gift card). The bank that ultimately assumes (or buys) your loan will send you a notice of where to send future payments. The good news is that if you were in the rare situation where your deposits at the same failed bank totaled over FDIC insurance limits, you may apply the excess to your loan balance and avoid the possibility of it blowing away like chaff in the wind.
Stocks, Bonds, Mutual Funds, and Safe Deposit Boxes
Though it is becoming more difficult in the Volcker Rule banking age to invest in securities through FDIC-insured banks, there are still institutions that maintain a brokerage arm off of their banking business through which they sell securities, or other non-deposit investment products, to consumers. It is important to know the difference between the various types of accounts that may be associated with a single banking institution. The FDIC does not insure stocks, bonds, mutual funds, or safe deposit boxes against a bank’s failure. This insurance function is provided by a non-governmental organization called SIPC (the Securities Investors Protection Corporation).
ATMs Still Work in the Midst of a Bank’s Closing
ATM transactions that you perform during the time between your bank being closed and reorganized (by the FDIC or the acquiring bank) won’t post immediately because the ATMs are taken offline for processing by the FDIC. Upon the bank’s reopening, all of the transactions you completed via an ATM will be updated to your account.
Online Banking Doesn’t Always Work
Online banking services, however, could be closed during the failed bank’s transition. In the case of an Internet bank failing, consumers with deposits held by the bank may be more limited in the account management tasks they can perform. The FDIC does try to make sure web-based banking services associated with a failed bank remain continuously available.
Services and Accounts That Automatically Transfer to the Acquiring Bank
Despite the possibility of your bank failing becoming a headache, there are a few automatic transfers that will prevent your “to do” list from getting any longer. If you had automatic payments, loan payments, or direct deposits for your paycheck scheduled to occur regularly, those services will continue without you lifting a finger. Any trust accounts held at the failed institution will also be automatically transferred to the acquiring institution.
Though Bank Failures Make More Headlines, Credit Unions Fail As Well
The NCUA is the credit union version of the FDIC and functions in much the same way when a credit union becomes insolvent. Credit unions have a few more exemptions in the tax arena than banks, but they aren’t necessarily a safer place to hide from institutional failure. The NCUA’s guidelines for insurance coverage are similar to the FDIC and have insurance limits of $250,000 per member, which could be more depending on the type of account ownership.
Be Thankful for FDIC and NCUA Insurance
Finally, if you are one of the millions of beneficiaries of the insurance provided by the FDIC or NCUA, be thankful that not one dime of insured deposits have gone unpaid. While every system has its limitations and imperfections, it is a good thing that consumers don’t have to constantly think about how to secure all of their money.
Should you take advantage of the above lessons, you’ll be better prepared for and know how to respond when your bank is in the headlines for “Latest Failure”. Hopefully, though, some of the tools introduced will help you avoid such a scenario altogether. Check out more tools and lists on the failed banks page of the FDIC.
Patrick Russo writes for DepositAccounts.com, a website that monitors products and rates at more than 7,500 banks and credit unions and pairs that information with comprehensive commentary, reviews, tools, and community forums to equip and guide depository banking consumers.
(Photo courtesy of Andy Hawkins)