What Happens When a Bank Goes Out of Business

Last week I wondered in a comment to a post on The Simple Dollar about what the FDIC insurance claims process is really like when a bank fails. If a bank fails, do you get paid right away, or do you have to wait until everything is sorted out? For how long? How do you prove how much you had in your account if the bank’s computer is screwed up because the bank failed?

As if I jinxed it, there was news report about a bank failure in Pittsburgh on the same day. It was the first bank failure in the country since June 2004, no less. Here’s an excerpt from the news report on Pittsburgh Post-Gazette:

“Mr. Cavacini is one of 1,453 Metropolitan Savings account holders tangled up in the first Pittsburgh-area bank seizure since the collapse of FS&LA of Pittsburgh in 1991 — and the first in the United States since June 2004. The Pennsylvania Department of Banking shut down the Lawrenceville bank Friday and handed the keys to the Federal Deposit Insurance Corp.”

So there we have it, a perfect example to study what really happens when a bank goes out of business and how the FDIC protects the bank customers. On Friday Feb. 2, 2007 the Pennsylvania state bank regulators shut down Metropolitan Savings Bank and gave control over to the FDIC. The FDIC quickly solicited bids from other banks and awarded the failed bank to another bank, Allegheny Valley Bank, which operates in the same town. Allegheny Valley Bank and FDIC personnel moved in to the failed bank, took the weekend to organize the books and re-opened the failed bank as a branch of Allegheny Valley Bank on the following Monday. That was quick! All customers of the failed Metropolitan Savings Bank became customers of the succeeding bank Allegheny Valley Bank.

However, some 70 unlucky customers had balances over the FDIC insurance limit at the failed bank. They will become creditors to the failed bank. The FDIC will sell off the the failed bank’s assets and pay them from the proceeds. That process can take years. The lesson learned? Don’t keep over $100,000 at any bank — not a problem for me because I don’t have that much money!

Bank failures are rare but they still happen. According to the FDIC, there were 28 bank failures since October 2000, averaging 4-5 a year. In most cases, the FDIC would arrange another bank to take over the deposits at the failed bank and the customers continue on without harm. When the FDIC couldn’t find a buyer, it paid out the insured balance from its own fund (for example, NextBank failure in 2002). This fast action gives me comfort in the system. One of my questions remains unanswered:

How do you prove how much you had in your account if the bank’s computer is screwed up because the bank failed?

I think for this reason, I will continue to favor larger international or national banks over smaller no-name banks. Because security and control are largely a fixed cost, in other words, a bank needs to invest in more or less the same level of security and control whether it has 10,000 customers or 10,000,000 customers, a larger bank will have more resources for security and control.



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  1. William says

    Great post. As I noted in the Carnival of Personal Finance, I have started a Financial Education web site. If you would be interested in contributing some articles, shoot me an e-mail.

    Bill Trent
    Stock Market Beat

  2. Allan says

    Awesome information! I’ve always wondered what would happen to a bank who bailed out. I was thinking, “Does the FDIC have enough money to insure that many people?” But I guess most of the time, it deals with other banks buying the deposits of the failed bank instead of just paying out the deposits to the account holders.

    The Information Bank

  3. Kenneth Fink says

    what happens to your CD at an FDIC insured bank that fails? Is you CD principal returned? What about the interest? Do you have to pay penalties if they are paying you off early because of the failure (rather than your own request to get out of the CD early) or does the new bank honor the interest rate in the CD contract that you signed with the failing bank?

  4. Harry Sit says

    The principal and accrued interest in your CD are insured up to the FDIC limit. The assuming bank has the option to hold you to the original rate and term OR cash you out (without penalty) and let you redeposit into their existing products or take your money elsewhere. It’s their choice, not yours.

  5. Kenneth Fink says

    thank you. I had been able to get answer from the FDIC or any bank I queried. Thanks.

    Ken Fink

  6. louise says

    I have a problem. Need your input. Cal nat’l. bank in los angeles . I deposited $35,000. This bank cleared the check. Went to window to get out. Manager said will take 90 days for me to get out. I said no way! I called asst. to ceo/executive, downtown l.a., Erick, who said this is the way all banks work. I said no way. I told them that you cannot hold onto money. They finally gave in to giving me every friday for five weeks bits and pieces of my money back.
    Now , right before my cd ends and I collect interest, Erick the same asst. to the executive ceo; but this time it is to Mr. Davis , the new ceo of us bank.
    He does a dr. spin. In other words, he does not care nor will help customers. His boss , does not know. He tells me that you cannot get your interest on your cd because we are terminating all your accounts with our bank, including your cd ready to cash out. But the manager at the branch again does not want to go through (follow through) with the federal deposit insurance coverage (fdic). He told me that we couldn’t hold onto you check this summer for ninety days but now we won’t let you get your interest on your certificate of deposit.

    PLEASE HELP!!! Tell me what to do………. The letter I received is a xerox copy of an emblem of cal nat’l. bank on the top with (no signature) and (no name typed in).
    But it says your accounts will be all closed Dec. 11, 2009.

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