“What happens if my bank closes?” is a question I sometimes get from clients. This concern can be even more pointed when another borrower/customer of a small, local bank goes out of business. If the bank lost hundreds of thousands of dollars on that other borrower’s/customer’s failure, isn’t my deposit in that bank at risk?
Generally, there is no need to worry in this context. There are multiple, duplicative methods used to protect money, particularly when deposited in banks.
First, money in banks is protected through our government’s bank auditing and examination laws. Banks are audited at least annually. The government auditors and examiners attempt to make sure that all the money that should be in the bank is actually in the bank (precluding or uncovering embezzlement or theft).
Just as importantly, bank examiners also compare and contrast the size of the bank in relation to its biggest borrowers. In other words, small banks are only legally allowed to loan so much money to any one customer. If that customer failed to repay its loans, the bank would still be able to pay its obligations to depositors. This is commonly called a “lending limit,” and the lending limit is different for each bank.
Small local banks (of which I am a huge fan) can still be involved in large businesses’ loans, but they may have to “partner up” with other banks so that the risk of business failure is spread across multiple banks. This is called “participation.”
Second, the money that banks loan is not always the bank’s own money. For example, many home loans are funded through money that local banks borrow from others, such as Fannie Mae and Freddie Mac. Thus, if that certain home loan fails, the local bank would not be the loser of the money.
Third, money in certain accounts at banks is protected through FDIC insurance. Generally, each depositor’s money up to $250,000 in any one FDIC-insured bank is “insured” by the federal government. This includes savings, checking and money market accounts, as well as certificates of deposit. However, FDIC insurance does not insure losses of stocks, bonds and mutual funds, even if an FDIC-insured bank administers those accounts.
A person with more than $250,000 may split that money among multiple banks so that the total amount in any one bank (and FDIC insured) does not exceed $250,000. However, this is usually not necessary. Almost all banks have computerized exchanges that provide FDIC protection for any amount.
For example, if a depositor keeps $300,000 at one bank, that bank may re-invest at least $50,000 in another bank through the computerized program. To the customer, all the money appears to be in one bank. But, in reality, the money is spread between two banks, keeping it all FDIC insured. Notably, this bank exchange system only protects customers who ask for it.
Federal credit unions use a government insurance program that is similar to FDIC that can provide government protection of certain money deposited in those institutions.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agriculture issues in northwest Ohio. He can be reached at Lee@LeeSchroeder.com or at 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed attorney of your choice based upon the specific facts and circumstances that you face.