What Happens to Your Money When a Bank Fails?

When a bank faces severe financial distress, it can lead to a bank failure. These events are uncommon in the United States due to robust regulatory oversight designed to maintain financial system stability. Various federal agencies, including the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board, and the Federal Deposit Insurance Corporation (FDIC), supervise banks to ensure they operate safely and comply with regulations. While bank failures are infrequent, mechanisms are in place to manage them effectively and protect depositors.

Protecting Deposited Funds

The primary safeguard for depositors during a bank failure is deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC). This U.S. government agency protects deposits in FDIC-insured banks. This insurance is automatically provided when an account is opened at an FDIC-insured institution. The FDIC’s coverage is backed by the full faith and credit of the United States government.

The standard insurance amount is $250,000 per depositor, per insured bank, for each ownership category. This means that if an individual has multiple accounts at the same bank under the same ownership category, their combined balance across those accounts is insured up to $250,000. However, holding accounts in different ownership categories can significantly increase coverage at a single institution.

Expanded Coverage Through Ownership Categories

Different ownership categories allow for expanded coverage.
A single account, owned by one person, is insured up to $250,000.
A joint account, owned by two or more people, provides $250,000 of coverage per co-owner, effectively insuring up to $500,000 for a two-person joint account.
Retirement accounts, such as Individual Retirement Accounts (IRAs) and self-directed 401(k)s, are insured separately from personal accounts, also up to $250,000 per owner.
Trust accounts, including revocable and irrevocable trusts, can offer substantial coverage based on the number of unique beneficiaries named.

FDIC insurance covers various deposit products, including checking accounts, savings accounts, money market deposit accounts (MMDAs), and Certificates of Deposit (CDs). It also extends to official items issued by a bank, such as cashier’s checks and money orders. This coverage protects both the principal amount deposited and any accrued interest up to the date of the bank’s failure.

However, not all financial products offered by banks are covered by FDIC insurance. Investment products like stocks, bonds, mutual funds, annuities, and life insurance policies are not insured, even if they were purchased through an FDIC-insured bank. The contents of safe deposit boxes are also not covered, as they are not considered deposits. U.S. Treasury bills, bonds, or notes are not FDIC-insured, but they are backed by the full faith and credit of the U.S. government.

Depositors can verify if their bank is FDIC-insured by looking for the FDIC logo displayed prominently at bank branches or on the bank’s website. Additionally, the FDIC provides an online tool called BankFind, where individuals can search for their bank’s insurance status. For a personalized estimate of their coverage, customers can use the Electronic Deposit Insurance Estimator (EDIE) tool available on the FDIC’s website.

The Bank Failure Process

When a bank becomes critically undercapitalized or is unable to meet its financial obligations, a state or federal regulator, such as the Office of the Comptroller of the Currency (OCC) or a state banking agency, will close the institution. The Federal Deposit Insurance Corporation (FDIC) is then appointed as the receiver for the failed bank, assuming control of its operations, freezing payments, and removing existing management.

The FDIC’s primary goal as receiver is to resolve the failure in a manner that is least costly to the Deposit Insurance Fund (DIF) while ensuring insured depositors have prompt access to their funds. The FDIC aims to return insured funds to depositors within two business days of the bank’s closing.

Methods of Resolution

There are two main methods the FDIC uses to resolve failed banks:

Purchase and Assumption (P&A): This is the most common and preferred method. A healthy bank acquires the failed bank’s insured deposits and, often, some of its assets. Insured depositors of the failed bank automatically become depositors of the acquiring bank and regain immediate access to their funds. This method provides a seamless transition for customers, as their accounts are simply transferred to the new institution.
Deposit Payoff: If a suitable acquiring bank cannot be found for a P&A transaction, the FDIC will proceed with a “Deposit Payoff.” In this scenario, the FDIC directly pays insured depositors up to the $250,000 limit for their accounts. The FDIC then takes possession of the failed bank’s remaining assets and sells them to recover costs. Uninsured depositors, those with funds exceeding the $250,000 limit, become creditors of the receivership. They receive a receivership certificate for their uninsured funds and may recover a portion of these amounts from the proceeds of the asset sales. Payments to uninsured depositors occur after administrative expenses and insured deposits have been addressed, and can take an extended period.

Impact on Customer Accounts and Services

A bank failure affects various customer financial products and services, but established protocols ensure continuity where possible.

Loans and Mortgages

For loans and mortgages, a customer’s obligation to repay does not cease. These loan agreements are typically transferred either to an acquiring bank in a Purchase and Assumption transaction or are managed by the FDIC as receiver. Borrowers must continue to make payments according to their original terms to the new entity.

Direct Deposits and Automatic Payments

Direct deposits, such as paychecks, and automatic payments, like bill pay or recurring transfers, are generally designed to continue with minimal interruption. If an acquiring bank takes over, these services are usually re-routed to the new institution. In cases of a direct payoff, the FDIC works to ensure that these automated transactions are quickly re-established or redirected, allowing for continued financial operations.

Outstanding Checks and Debit Card Transactions

Outstanding checks and debit card transactions initiated before the bank’s closure are handled during the transition period. When a bank closes, the FDIC needs to freeze all deposit accounts to determine insured balances. During this brief period, typically a day or two, outstanding transactions might be temporarily delayed or unable to clear. Once accounts are transferred to an acquiring bank or insured funds are paid out, normal transaction processing resumes.

Safe Deposit Boxes

Safe deposit boxes are not considered bank assets and are not insured by the FDIC. The contents remain the property of the box renter. In the event of a bank failure, the FDIC will provide a process for customers to access their safe deposit boxes and retrieve their belongings. This usually involves setting specific dates and times for customers to visit the failed bank’s location to collect their items.

Credit Card Accounts

Credit card accounts issued by a failed bank may be transferred to an acquiring institution, similar to loans. The acquiring bank would then assume responsibility for managing these accounts. If there is no acquiring institution for the credit card portfolio, the FDIC would manage the accounts, and customers would receive instructions on how to continue making payments or if new arrangements are necessary.

Online Banking and Mobile Applications

Online banking and mobile applications often experience temporary disruptions immediately following a bank failure as systems are transitioned. Customers might not be able to log in or access their account information during this brief period. Once an acquiring bank assumes the accounts, or the FDIC establishes new access points, online and mobile services are typically restored, allowing customers to manage their finances digitally.