In an era of economic uncertainty, knowing the warning signs of bank distress can help you protect your hard-earned money before a financial institution reaches the point of failure.
At a Glance
- Bank failures follow a pattern: losses lead to capital concerns, which trigger solvency fears and customer withdrawals, potentially causing a liquidity crisis
- Early warning signs include declining profits, increasing loan defaults, deteriorating service quality, and unexpected fee increases
- The FDIC protects deposits up to $250,000 per account holder per account type if a bank fails
- Protection strategies include using FDIC-insured institutions, not exceeding insurance limits, and diversifying financial holdings
- Individual vigilance through monitoring bank news and financial reports is crucial for safeguarding your finances
Understanding Bank Failures and Their Warning Signs
While bank failures are relatively rare, they can have significant impacts on the economy and consumer confidence. In 2023 alone, four U.S. banks failed, including Silicon Valley Bank, Signature Bank, First Republic Bank, and Heartland Tri-State Bank. Recognizing the early warning signs can help you take proactive steps to protect your finances before a situation deteriorates. These signs often manifest themselves in various ways, from service changes to financial indicators that appear in public reports.
“Bank failures almost always follow a similar pattern,” says Cory Frank, founder and CEO of Robora Financial. “Actual or expected losses lead to questions about capital adequacy, which then spark concerns about solvency. Fears around solvency often prompt customers to take self-preserving actions, such as pulling deposits. These actions, in turn, can cause a liquidity crisis. Liquidity risk is unique among risk types in that the perception of a problem can create a real problem—customer behavior itself can drive a bank or credit union to fail.”
Poor risk management is one of the leading causes of bank failure. This can involve making bad loans or risky investments without proper procedures in place to mitigate potential losses. Another key factor is asset liability mismatch, which occurs when banks’ short-term borrowing and long-term lending are not aligned, exposing them to interest rate risk. In some cases, internal fraud such as issuing fraudulent loans or manipulating financial statements can lead to significant financial losses and destroy trust in the institution.
Service-Related Warning Signs
Before financial problems become publicly known, customers may notice changes in service quality that hint at underlying issues. A bank struggling financially may close branches or reduce ATM services to cut costs. You might experience unexpected increases in fees or notice deteriorating customer service as the institution attempts to improve its bottom line through cost-cutting measures. These service changes often represent efforts by the bank to regain profitability in the face of financial challenges.
“There doesn’t need to be a deep recession or collapse of the economy if there are internal problems at the bank that the public is simply unaware of,” says Adem Selita, co-founder of The Debt Relief Company. “However, banks do undergo stress tests and are checked for these issues quite often in order to minimize the risk of this happening. But that doesn’t mean the system is foolproof.”
When banks activate what insiders call a “Recovery Playbook,” you might notice aggressive deposit campaigns offering unusually high interest rates. This is often a last-ditch effort to attract funds when other sources of capital have dried up. Other visible signs include the cutting of stock dividends and selling of assets to raise cash quickly. Any drastic change in a bank’s normal business operations deserves careful attention from customers.
Financial Indicators of Bank Distress
For those willing to do some research, there are several financial indicators that can signal a bank is in trouble. Declining profits over multiple quarters, increasing loan defaults, and a high ratio of non-performing assets are significant red flags. These indicators are typically available in public financial reports that banks are required to file. A sudden surge in withdrawals, often called a “bank run,” indicates a serious loss of consumer confidence and can accelerate a bank’s decline.
Negative articles or analyst reports highlighting issues like liquidity problems or non-compliance with regulations can further signify underlying concerns. Financial experts recommend monitoring your bank’s Call Report (for banks) or the National Credit Union Administration report (for credit unions) to spot negative trends. These reports can reveal capital adequacy issues, which are often precursors to more serious problems. Economic conditions, including downturns and policy changes, can increase bad loans and affect banks’ profitability and solvency.
Protecting Your Finances
If you spot warning signs at your bank, there are several steps you can take to protect your finances. First, ensure your deposits are FDIC- or NCUA-insured, which protects up to $250,000 per account holder per account type. If you have more than $250,000, consider spreading your money across multiple banks or account types to stay within insurance limits. Diversifying your financial holdings across different types of institutions can further reduce your risk exposure.
“Stay informed,” Frank says. “Search for recent news about your bank or credit union for any of the red flags mentioned. Analyze financials, if you can: Download and review the institution’s Call Report (for banks) or the National Credit Union Administration report (for credit unions) to spot negative trends.”
In the event of a bank failure, the FDIC typically moves quickly to establish a “bridge bank” or transfer assets to another FDIC-insured bank to ensure depositors can access their funds. Borrowers must continue to make loan payments even if their bank fails, as loans are typically sold to another bank. It’s worth noting that the U.S. government classifies major banks like JPMorgan Chase, Bank of America, Wells Fargo, and Citi as “too big to fail,” which means they receive additional regulatory oversight to prevent collapse.
Staying Vigilant in a Changing Financial Landscape
The financial system has implemented numerous safeguards since the 2008 crisis, including regulatory frameworks like the Dodd-Frank Act and Basel III, which have strengthened the banking sector’s resilience. Technological innovations and global coordination among regulatory bodies continue to improve risk management capabilities. However, these systems are not infallible, and individual vigilance remains essential for protecting personal finances.
A survey by the FDIC showed that 96.5% of US households had access to at least one insured deposit account in 2019, demonstrating the widespread availability of protected banking services. By understanding the warning signs of bank distress and taking appropriate precautionary measures, you can navigate the financial landscape with greater confidence and security. Remember that staying informed and proactive is your best defense against potential banking troubles in an ever-evolving economic environment.
