Some banks use a -based reasoning system to qualify customers for loans, using _____.

Abstract

Banks offering credit to borrowers are faced with uncertainty about their creditworthiness. If banks obtain information about borrowers after lending to them, they are able to reject riskier borrowers when refinancing. Potential entrant banks will face an adverse-selection problem stemming from their inability to distinguish new borrowers from old borrowers who have been rejected by their previous bank. We analyze the effects of asymmetric information on the market structure of the banking industry. We characterize the equilibrium under Bertrand competition with two banks, and show that an equilibrium where a third bank enters does not exist (blockaded entry).

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The purpose of the RAND Journal of Economics, formerly the Bell Journal of Economics, is to support and encourage research in the behavior of regulated industries, the economic analysis of organizations, and more generally, applied microeconomics. Both theoretical and empirical manuscripts in economics and law are encouraged. Website: www.rje.org

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Banks are the safest place to keep your money, but bank failures do happen. To protect yourself and avoid panic if your bank goes under, it's important to understand the situation and what you can do about it. The main thing to remember is that as long as your funds are insured by the Federal Deposit Insurance Corporation (FDIC)—and they likely are—then your money is safe.

What Causes Bank Failures

Banks fail when they're no longer able to meet their obligations. They might lose too much on investments or become unable to provide cash when depositors demand it.

Ultimately, failures happen because banks don't just keep your money in vaults. When you walk in and deposit cash (or deposit funds electronically), the bank invests that money. A simple form of investment is making loans to other bank customers so they can earn interest—and pay you interest on your deposits.

Banks also invest in much more complicated ways. If the bank takes large losses in any one area, it risks failing.

What Happens in a Bank Failure

Most U.S. banks are FDIC-insured. If your bank is one of them, then you can count on the FDIC to make sure you get your money in the event of a failure.

The FDIC's first choice is for a healthy bank to assume the insured assets of a failed bank. In some cases, this option is not available, and the organization will cut you a check for your insured deposits.

Note

The FDIC does not publish a specific timeframe for resolving bank failures. The organization notes that historically, it has made funds available within one business day. They try to close banks down on Fridays and get back to "business as usual" by Monday morning. However, circumstances with a given bank failure or with your accounts can slow the process down.

The FDIC insures deposits up to $250,000, so keeping more than that at any bank may put your money at risk. However, it is possible to have more than $250,000 insured at one bank if several people or entities have an interest in the money. For example, retirement accounts and savings accounts for different family members can increase your protection. Take the time to understand FDIC limits if you have more than $250,000 at the bank.

For many customers, a bank failure is a non-event. They continue to use the checks, debit cards, and electronic transfer instructions that they used before the bank failure. At some point, customers may eventually get new checks and cards.​

Uninsured Deposits

If you're not banking at an FDIC-insured institution, you're taking a huge risk. When these banks fail, the FDIC takes over. They may sell the bank to another (stronger) bank, or they may operate the bank for some time as a federally owned bank.

If you have uninsured deposits at an FDIC-insured institution, you may have a problem. The FDIC typically makes insured deposits available immediately after a bank failure, but uninsured deposits may not be available for years. The FDIC has to sell the institution and its assets and see how much money (if any) is left to distribute to creditors.

Note

Sometimes, bank branches are destroyed as a result of natural disaster or terrorism. Physical destruction is different from a bank failure. Again, if your accounts are insured, the event is most likely just an inconvenience and not something that will completely ruin you. ​

Bank Runs

After a bank failure is announced, there is little reason to make a run on the bank, or withdraw your deposits, if your assets are insured. If the FDIC has already taken over, your money is no longer held by the weak and failing bank. If you want to get your money out and use a different bank, you can write a check or transfer your money electronically to the new bank.

If the FDIC has not found a successor bank, you will not have access to your money, and you'll have to wait for a check from the FDIC. In either case, there's nothing you can do after a bank failure is announced to affect how much money—if any—you'll lose.

Avoiding Bank Failures

It is difficult to know which banks will fail. The FDIC does not announce bank takeovers ahead of time. The best course of action is to make sure that you’re observing FDIC limits and not taking any risks.

Some bank rating services may help you avoid bank failures. These services look at banks’ strength, business models, and exposure to various risks.

You can also gain some insight by calculating your bank's Texas Ratio: divide the value of all non-performing assets by equity capital plus loan-loss reserves. If this ratio exceeds 100%, then there's usually a greater chance that the bank will fail.

However, bank failures can be difficult to predict, especially by outsiders, so it's wise to keep your funds insured.

Frequently Asked Questions (FAQs)

How many banks fail every year?

Since 2010, bank failures have been in a steady decline. In 2020, four banks failed, but in 2021, there were no bank failures. As of mid-2022, there have been zero additional bank failures.

What happens when credit unions fail?

Credit unions fail for similar reasons that banks fail. Credit union deposits aren't covered by the FDIC, but they are covered by a similar body called the National Credit Union Administration (NCUA) for deposits up to $250,000. Federally insured credit unions are just as safe as banks insured by the FDIC.

Are the items I have in my safe deposit box insured by the FDIC?

Items in a safe deposit box aren't insured by the FDIC, but your items would probably be safe in the event of a bank failure. Since failed banks are usually taken over by other banks, your safe deposit box would remain the same. If the branch were to close, or if another bank didn't take the bank over, you'd be notified by the bank or the FDIC on how to take possession of your items.

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