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What is Bank Insolvency?

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  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 23 September 2016
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Bank insolvency is a situation where a bank is unable to meet its financial obligations and must either close or restructure to address the problem. European nations tend to use the term “insolvency” to describe situations where banks are failing, while in the United States, people may call it a “bank failure” or “bankruptcy.” Bank insolvencies are somewhat different from regular business insolvency because the collapse of the bank could cause significant financial problems for bank customers. As a result, regulatory agencies may be involved in the process.

Banks can become insolvent for a variety of reasons, ranging from failing to meet reserve requirements to having a high default rate on the debt they issue. Bank regulation has specific mandates in place to reduce the risk of bank failures and catch problems at banks early. If a bank suspects it has a cash flow or debt problem, it can be taken over by an administrator who will attempt to help the bank recover, negotiate a deal for a sale, or close the bank.

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During bank insolvency proceedings, accounting logs are inspected to generate a list of bank creditors. Banks are typically insured and funds will be returned, up to a certain amount, to people who had money on deposit with the bank. To reduce consumer panic, the process is typically handled as quickly and quietly as possible; staff may move in during the weekend to take over a bank, for example, allowing it to open for business on Monday with minimal disruption.

Economic uncertainty tends to be accompanied with a rise in bank insolvencies. Under normal financial conditions, a handful of banks may fail in a given year. Once multiple large banks start to fail, a domino effect can occur, with smaller banks being dragged down as consumers start to panic and people fail to pay on their debts. In an economic climate where bank insolvency is a common problem, strike teams of regulators and government representatives may be developed in order to respond quickly to failing banks.

Regulatory agencies usually want to encourage banks to stay open by any means possible. In some cases, restructuring during a bank insolvency can allow a bank to reopen, and the bank will be monitored to confirm it is adhering to the terms of the restructuring. In other instances, a sale of the bank to another firm can be negotiated, with the firm taking on the debt obligations of the bank. Regulators usually offer a sweetener to the bank insolvency deal to encourage companies to buy failing banks and turn them around.

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Animandel
Post 4

Can you imagine what would happen if bank deposits were not FDIC secured and a rumor began that a bank was about to go under? Then again, I guess this is why so many people didn't put their money in banks years ago when there was no insurance on their money.

By the way, the $250,000 limit was originally supposed to be a temporary raise, and the limit was scheduled to go back to $100,000. However, the increased limit has now been made permanent.

Drentel
Post 3

While $250,000 of insurance for your deposits in banks is much better than it was a few years ago when the limit was $100,000, this amount is still less than many people have in bank accounts. One way for married couples to get around this limit is for them to have accounts in different names.

For example, my wife has an account at our bank in her name. I have an individual account in my name, and then we have a joint account in both of our names. All three accounts are covered under the FDIC insurance program. This means we could have up to $250,000 in each account and all the money would be covered if our bank went through bankruptcy because of insolvency.

Sporkasia
Post 2

@Laotionne - In the United States, the federal government insures up to $250,000 of a depositor's money in a bank that is subject to this insurance. Something many people do not know is that not all banks are FDIC insured, so if you have money in one of the banks not insured by the federal government then bank insolvency could result in you losing all of the money you have in the bank.

Also, not all accounts are FDIC insured, even when the bank where the accounts are held is FDIC insured. Savings and checking accounts are usually covered. Knowing the specific rules is important. These are definitely rules you should discuss with your banker before you open an account of any kind.

Laotionne
Post 1

How much of my money in the bank is covered should the bank experience insolvency? Is this amount up to $100,000?

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