What Is a Bank Failure & How To Protect Your Small Business

Business bank failure is when a financial institution is closed by federal or state regulators. The 2023 failures of Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank sent shockwaves through the business community. They were the first three bank failures since October 2020. And while the occasional bank failure isn’t uncommon, it is unusual for a bank failure to have such an impact on business bank customers.

Nevertheless, the SVB disaster serves as a reminder to businesses that bank failures can happen. It is important to ensure you protect your business from a future bank failure. This guide will help you understand bank failures, discuss the role of the Federal Deposit Insurance Corp. (FDIC) during a failure, give you steps to limit your risk, and advise you on what to do if your bank fails.

Financial technology company Mercury Mercury is a fintech company, not an FDIC-insured bank. Banking services provided by Choice Financial Group and Evolve Bank & Trust ®️; Members FDIC. Deposit insurance covers the failure of an insured bank. is doing its part to help businesses limit the risk of major financial losses during a bank failure. The company’s new product, Mercury Vault, uses partner banks and sweep networks to insure your business funds for up to $5 million with the FDIC Mercury is a fintech company, not an FDIC-insured bank. Deposits in checking and savings accounts are held by our banking services partners, Choice Financial Group and Evolve Bank & Trust ®; Members FDIC. Deposit insurance covers the failure of an insured bank. Certain conditions must be satisfied for pass-through insurance to apply. . Visit Mercury to sign up for a business bank account and to learn more about Vault.

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Video: Protecting Your Business From Bank Failure: 5 Things You Need to Know

How Do Banks Fail? Four Causes of Business Bank Failure

The FDIC lists four reasons why a bank can fail:

1. Undercapitalization: This occurs when a bank does not have enough capital to conduct ordinary business operations. A bank must have enough capital to cover all deposits, either in liquid funds or investments that the bank can liquidate.
2. Liquidity: Best defined by the Office of the Comptroller of the Currency (OCC), liquidity is the risk to a bank’s earnings and capital arising from its inability to timely meet obligations when they come due without incurring unacceptable losses.
3. Safety and soundness: According to the FDIC, it is the ability to avoid actions or lack of actions that are contrary to generally accepted standards of prudent financial institution operation that, if continued, would result in an abnormal risk of loss or damage.
4. Fraud: These are illegal activities, including undue dependence on the bank for income or services by a board member or shareholder, inappropriate transactions with affiliates, or unauthorized transactions by management officials.

While these four items are the primary causes of bank failures, bank runs often exacerbate them.

For example, the combination of a bank run and liquidity issues caused the downfall of SVB. When word spread that the bank intended to raise capital, depositors worried that it was because the bank was in financial trouble. This caused a run on the bank.

Because SVB had much of its finances tied up in mortgage-backed securities, it did not have the appropriate amount of liquidity to meet the demand from its depositors. It could not liquidate its funds quickly enough, and the bank failed.

Had the bank run not occurred, SVB would have been able to liquidate its assets slowly and cover the demands of its depositors. In that case, the bank would have likely survived.

Three Major Historical Bank Failure Events

Bank failures, while relatively uncommon in recent years, have occurred regularly throughout United States history; for the full list, see the FDIC’s failed bank page. While they most often happen in small numbers, several historical events have triggered large amounts of bank failures in a short period.

According to BankingStrategist.com, three significant events caused major banking failures over the last century.

From 2018 to 2022, there were only eight bank failures with total deposits of $672.1 million. By comparison, the failures of SVB, Signature Bank, and First Republic Bank affected total deposits of $548.5 billion.

The largest amount of deposits affected by the Mortgage Crisis occurred in bank failures from 2008-2010. There were still failures after 2010 related to the crisis, but they affected smaller amounts of deposits.

FDIC Insurance During Bank Failure: What You Need to Know

Before discussing what the FDIC does during a bank failure, it is important to understand how FDIC insurance for business works. FDIC insurance is a limited form of banking failure protection for businesses and individual customers. The insurance protects a portion of your company’s assets during a bank failure.

Different types of accounts are insured to a different amount depending on the structure of the account. Click the header below to see the FDIC insurance limits for each business structure.

FDIC Insurance Limits

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Accounts Covered by FDIC Insurance

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Accounts Not Covered by FDIC Insurance

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What Happens When a Bank Fails: FDIC’s Role

In the event a bank fails, the FDIC steps in to create an entity called a receivership. This entity will oversee the operations and resolution of the failed bank. Accounts that are covered by FDIC are insured, as indicated in the table above.

One of three agencies can close a failed bank: the OCC, the Office of Thrift Supervision (OTS), and state banking authorities. At this point, with federal savings and national banks, the FDIC is appointed receiver of the bank. In the case of a state-chartered bank, the state can appoint the FDIC receiver.

The FDIC will then attempt to sell the assets and liabilities of the bank to another FDIC institution.

There are two actions that the FDIC can take to resolve a closed bank:

1. Purchase and assumption transaction: This is the method the FDIC prefers. A healthy bank assumes the insured deposits of the failed bank. Those depositors become customers of the new bank and will have access to their insured funds. The healthy bank can also purchase loans and other assets of the failed bank.
2. Deposit payoff: If the FDIC cannot find a bank to purchase the failed bank’s deposits, it will pay the depositor directly by check an amount up to the insured balance. Those payments typically begin within days of the bank closing. As assets are liquidated from the failed bank, depositors can file claims against the estate of the closed bank. They will be repaid a prorated amount, up to 100% of the claim, if there are sufficient assets after liquidation.

How To Limit Your Risk in the Event of Bank Failure

While the easiest way to limit your risk in the event of bank failure is to keep less than $250,000 in your business bank account, this is not possible for all businesses. Here are two reasons businesses might not be able to stay below the FDIC-insured limit:

1. Larger companies may have payables exceeding $250,000. Whether it is the company’s payroll or other larger expenses that the company owes, a business might need to have more than $250,000 to cover those expenses.
2. Companies may have receivables greater than $250,000. As large sums of money are paid by the company’s customers, the business could exceed the FDIC limit.

Listed here are steps for how to protect your business from bank failure. Not every step will be possible for every business, depending on the size of the business. However, following as many as possible will help protect your business from catastrophic bank failure.

1. Open Accounts at Multiple Banks

It is not enough to split funds into multiple accounts in the same bank. When calculating the amount of funds insured by the FDIC for a particular business, all of the funds for that business in a particular financial institution are added together and counted towards the insured amount.

In other words, if your business has five accounts with the same bank, the total of all five accounts is added together when determining how much is insured. To avoid that issue, move funds that would exceed the FDIC insurance amount into another financial institution.

Here are two examples of how this would work.

2. Move Funds to a Credit Union

Credit unions have their own federal insurance separate from the FDIC. It is available through the National Credit Union Administration (NCUA), which insures accounts up to $250,000. See our buyer’s guide to the leading credit unions for small businesses for the best options.

3. Choose a Bank That is a Member of the Depositors Insurance Fund (DIF)

The DIF insures funds above the FDIC’s limit. On its website, you can see the banks that are members of both the FDIC and DIF.

4. Find Other Providers of FDIC Insurance

There are external companies that provide additional insurance above FDIC limits. Wintrust has a program called MaxSafe, which insures accounts up to $3.75 million.

5. Keep Enough Funds Liquid to Manage Short-term Emergencies

While it is important for businesses to invest funds to continue long-term growth, it is also crucial to have short-term liquidity to deal with a potential bank failure. When planning your investments, stagger timed investments such as certificates of deposit (CDs) that are part of a CD ladder so that you have funds available regularly.

In addition, funds in overseas banks may not be easily liquidated in the event of an emergency. Also, those funds may not be insured in the event of a foreign bank failure. It is best to keep as much of your business finances in domestic banks as possible.

Some companies were unable to meet payroll obligations in the immediate aftermath of the SVB failure. Ensure your financial planning includes having enough liquidity to cover at least 30 days’ worth of expenses. This should protect you until the FDIC starts issuing checks to cover failed bank assets.

6. CDARS and ICS through IntraFi: How Banks Insure Customers Beyond $250,000

Banks and financial technology (fintech) companies have the ability to insure business funds beyond the $250,000 limit using IntraFi Network Deposits. That company combined Certificate of Deposit Account Registry Service (CDARS) and Insured Cash Sweeps (ICS).

IntraFi, a network of more than 3,000 banks nationwide, provides CDARS and ICS to allow banks to spread deposits across multiple financial institutions, with customers receiving $250,000 of FDIC insurance at each bank.

CDARS has limited liquidity because it’s a CD. In the event of a financial emergency, you will likely have to pay a penalty for early withdrawal. Banks also have to pay a fee to access a CD in CDARS, making the return on investment for the bank less than other options.

You must pay fees on an ICS as well, which will limit the rate of return. However, you can insure up to $150 million with an ICS, which should cover the finances of most small businesses. Check with your current bank to see if it offers CDARS or ICS, which can allow you to increase your protection.

Mercury is your best choice for a business bank account that uses cash sweeps and partner banks to insure your funds up to $5 million Mercury is a fintech company, not an FDIC-insured bank. Deposits in checking and savings accounts are held by our banking services partners, Choice Financial Group and Evolve Bank & Trust ®; Members FDIC. Deposit insurance covers the failure of an insured bank. Certain conditions must be satisfied for pass-through insurance to apply. . In addition, you can get access to a treasury account that will earn a strong APY on all funds above $250,000 Mercury Treasury, by Mercury Advisory, LLC, an SEC-registered investment advisor. Registration with the SEC does not imply a certain level of skill or training. SEC registration does not mean the SEC has approved of the services of the investment adviser. . See our review of Mercury’s business checking for more information.

Below are two fintech options and one online bank for insuring more than $250,000 for your business.

What You Should Do If Your Bank Fails

If your business bank fails, there are several steps you should take to protect your business.

1. Communicate with Shareholders, Clients, Customers & Employees

Transparency is critical when dealing with the fallout from bank failure. It is essential to let your key stakeholders know how the failure is impacting your business, both short-term and long-term. Let them know the steps you are taking or have taken to ensure minimal impact on your company.

If there are significant impacts, communicate them immediately and let stakeholders know your plans to overcome them. The sooner you get out in front of the issue, the faster you can deal with the fallout and get back to business as usual.

2. Understand What is Happening With the Failed Bank

Not every bank failure is the same. For example, with Signature Bank and First Republic Bank, bank assets were sold before the FDIC created a bridge bank. With SVB, the FDIC first created a bridge bank before selling the assets.

If you had funds that were above the insured limit in a failed bank, find out:

• Whether you will get those funds back
• How soon you will get your funds
• If any action needs to be taken on your part such as filing a claim

3. Open a New Account at a Healthy Bank

Once your bank fails, open a new business account at a healthy bank—don’t wait for the receivership to start sending you business funds. You need to establish a new banking relationship, so the sooner this is done, the better. If you already have accounts in other banks, you may be able to use one of those accounts instead. Just be mindful of those banks’ FDIC limits to ensure your company is protected.

4. Transfer Auto Payments Into an Account at Another Bank

If you have auto payments coming in or going out of your account at the failed bank, see to it that you get those switched over to either your new account or another existing account at a healthy bank.

5. Continue Paying Any Loans, Credit Cards, or Lines of Credit

If you have an outstanding debt with a failed bank, ensure you continue making payments. Some bank credit cards, for example, are managed by backer banks and may be unaffected by bank failure. The bridge bank, or the bank that buys the loans from the failed bank, should inform you where you need to send future payments. You don’t want to risk your business or personal credit because you missed payments in the aftermath of a bank failure.

Bottom Line

While some business owners may be nervous about last year’s failures of Silicon Valley Bank, Signature Bank, and First Republic Bank, it is important to know that significant bank failures have been relatively uncommon in recent years. However, it is an excellent time to assess your company’s banking strategy to protect your finances in case of a future bank failure. By preparing an effective plan to ensure your finances are insured, you can know that your business will be safeguarded against a future financial catastrophe.