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What is a Bank Failure?

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  • Written By: Jacob Queen
  • Edited By: Lauren Fritsky
  • Last Modified Date: 06 October 2018
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    Conjecture Corporation
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A bank failure is something that occurs when a bank has insufficient funds to deal with its debts. When people put money into a bank, that money is often invested and used for different purposes, but the bank generally offers a guarantee that it can produce the money when it is needed. If the financial situation at a bank deteriorates to the point where it is not possible for it to handle requests for money, it is forced to shut down, and a bank failure occurs. The shutdown of an offending bank is usually mandated by the laws in the country where the bank resides, and the exact requirements for a bank failure can vary in different places.

A lot of things can cause a bank failure. Generally speaking, when there is some kind of economic downturn, some bank failures are possible. This is because banks often invest their money in various markets, including real-estate, for example. If those markets deteriorate, the value of the bank’s funds may be greatly exceeded by the amount it owes, and the government may command the bank to shut down.

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In many places, governments either insure bank deposits, or there is access to some kind of deposit insurance. For example, in the United States, there is a government institution called the Federal Deposit Insurance Corporation (FDIC), which handles bank failures. Banks that are insured by the FDIC are required to have a special sticker prominently displayed, and customers can safely deposit up to $250,000 US Dollars (USD). Anything up to that point will be replaced by the government if the bank fails.

If people deal with banks that aren’t insured or deposit more than the safe amount in a single account, then they could potentially be in peril if there is a failure. When using the FDIC, there are ways that customers can deposit more than the limit, but in many cases, they may choose to use different banks for any funds over that level. Bank failures aren’t all that common, but most experts recommend being very diligent about only using insured banks.

A bank failure can have a big impact on the economy. Small banks can potentially fail without causing any kind of disaster, but large banks can create a ripple effect that causes other banks to fail and even ruins other businesses. Sometimes governments will step in and rescue failing banks in order to protect the economy. There is a lot of disagreement about whether or not this is a good practice, and some economists feel that it undermines the free market and causes some banks to take undue risks.

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