By: Raj Tulshan – Founder and managing member of Loanmantra.com
In March 2023, two U.S. banks failed, this triggered plummeting stocks, a fast response by regulators to prevent additional fallout, and concerns from many Americans who wondered if their money was safe. These banks, Silicon Valley Bank and Signature Bank, had depositors withdraw more money than the bank had available. Silvergate Capital Corp., which had significant crypto holdings, soon followed. And on April 28th, 2023, First Republic Bank was rumored to be the next to fall, with stocks plummeting over the course of days. What did these entities have in common? Each failed, in part, because they made high-risk loans, loaned too much within one industry (technology) and didn’t have enough assets to back the loans.
In the aftermath of this news business owners can feel uneasy. Understanding what a bank failure is and why they happen can help ease the stress and allow for better decision making. Here are some key financial terms surrounding these events from the experts at Loan Mantra.
What causes a bank failure? – A bank fails when the market value of its assets declines to an amount that is less than the market value of its liabilities. The insolvent bank either borrows from other solvent banks or sells its assets at a lower price than its market value to generate liquid money to pay its depositors on demand.
So why does a bank fail? – 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 because it no longer has enough liquid assets to fulfill its payment obligations. This might happen because the bank loses too much on its investments.
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 may sometimes provide reimbursement beyond its coverage limits.
Who pays for a bank failure? – Despite what is discussed in the media, the taxpayers are not financially liable when a bank fails. Most often, bailout of a failed institution is covered by the FDIC reserve, which is replenished through special assessments to existing banks. However, small businesses are stakeholders in the process and can be adversely impacted by a bank failure. Often, bank failure(s) can lead to disruption in inventory, payroll and availability to get cash to cover costs or improvements.
What’s a Bridge Bank? – A bridge bank is an institution that has been authorized by a national regulator or central bank to operate an insolvent bank until a buyer can be found. It is charged with holding the assets and liabilities of the failed bank until the bank is acquired by another entity or is liquidated.
How a Bridge Bank works – The FDIC has the authority, using a bridge bank, to operate a failed bank until a buyer can be found. Bridge banks may be employed to avoid systemic financial risk to a country’s economy or credit markets. They can assuage creditors and depositors and prevent negative effects, such as panics and bank runs.
How do I know my bank is safe? – Go to the FDIC’s BankFind database, where you can search for your bank by name. In the most recent wave of bank failures, aggressive lending can be a sign that your bank is not operating in a fiscally responsible way.
What’s the difference between a credit union and a bank? – Banks are for-profit, meaning they are either privately owned or publicly traded, while credit unions are nonprofit institutions.
What happens to my loan if my bank fails, is my loan forgiven? – Unfortunately, no. Loans held at banks that have failed are still your obligation to pay. Borrowers should be notified within a few days of a bank closure of where and when to send all future loan installment payments.
What are four warning signs of an impending bank closure? –
1. A drop in deposits – If you notice a large drop in deposits this may be a signal. The FDIC website contains year-to-year comparisons of total deposits for a bank. A sharp drop means other people are heading for the exits. (FRB)
2. Delayed financial reporting – if earnings are delayed when it comes to reporting financials they could be struggling with changes in valuations.
3. Cuts in services – healthy banks try to provide incentives for loyal customers. In a struggling bank, cost-cutting outweighs relationship-building.
4. Desperate Deposit Accumulation– Banks that are desperate to hold onto your deposit relationship may offer terms that are too good to be true. Likewise, if a bank does the opposite, hiking fees to get the most out of their customers, this may also signal trouble.
In addition, here are some key terms and definitions:
Bank Failure – A bank failure is the closing of an insolvent bank by a federal or state regulator.
Liabilities – the state of being responsible for something, especially by law.
Insolvent – unable to pay debts owed.
Deposit – a sum of money placed or kept in a bank account, usually to gain interest.
FDIC – The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the Congress to maintain stability and public confidence in the nation’s financial system.
Receiver’s Certificate – a debt instrument that is issued by the receiver of a business and that may have priority over other liens against the business.
Creditors – a person or company to whom money is owed.
Investment – the process of investing money for profit
Bridge Bank – a temporary bank set up by federal regulators to operate a failed or insolvent bank.
Bank runs – A bank run is when many clients of a bank or a financial institution withdraw their deposits at the same time over fears about the bank’s solvency.
Set off Clause – a legal clause that gives a lender the authority to stop a debtor’s deposits when they default on a loan/when you miss payments for a specified period.
Solvent – having assets more than liabilities; able to pay one’s debts.
Liquid Cash/Asset – an asset that can easily be converted into cash in a short amount of time.
These bank failures have nothing to do with thousands of other banks that are still running successfully. Community banks are in extremely good shape and banks are still issuing loans. It’s important to remember that the FDIC is in place to protect a certain number of deposits – and the people who made them. Additionally, the federal government created the Bank Term Funding Program on March 12, promising to return all depositors’ money, which helped stabilize unsteady markets. Although many people are concerned about the security of their deposits, there are many protections in place to keep your money safe.
Know that the FDIC protects your money. The Federal Deposit Insurance Corporation (FDIC) started after the Great Depression to protect depositors’ money. The FDIC automatically insures up to $250,000 in deposits per depositor and per insured bank. During a bank collapse like we saw in March, the FDIC ensures that bank customers will receive their insured funds, which is any deposit up to $250,000. In the unlikely event that your bank fails, the FDIC will reimburse your insured deposits, up to the $250,000 per person limit, if they are maintained with an insured bank or credit union.
Raj Tulshan is the founder and managing member of Loanmantra.com, a one-stop FinTech and financial advisory service that democratizes the loan process. Loan Mantra provides corporate sized services and capital to entrepreneurs, small and medium sized businesses. Connect with Raj and Team Loan Mantra at 1.855. 700.BLUE (2583) or email@example.com.