Banks are similar to any other business inasmuch as they can fail or succeed based on the actions of ownership and management. What makes a bank failure different is the fact that it can have such a negative impact on so many other institutions and individuals. It is not like a mom and pop shop where closing would negatively affect only business owners and a few employees. When a bank fails, that failure has a ripple effect that can trouble the entire economy.
A bank makes money by investing its assets (customer deposits and investment returns) by making loans and putting money into institutional investments. As long as its assets remain greater than its liabilities, the bank remains profitable. A bank becomes unprofitable when liabilities exceed assets. Should an unprofitable condition exist over an extended amount of time, the bank is considered a failure.
Government Regulation
The domino effect of bank failures has led the Government to put regulations in place to prevent total economic collapse. Therefore, a bank failure rarely results in the institution going out of business in the same way a clothing or electronics store might. Instead, a failed bank is temporarily taken over by the Government regulator until a solution can be found. Deposits are covered by federal insurance.
In most cases, a failing bank will be sold or merged with another similar banking institution. This protects customer deposits and alleviates the federal government from the responsibility of having to continue bank operations.
One of the largest bank failures in U.S. history was that of Washington Mutual (WaMu) in 2008. When the federal government seized WaMU, it was placed in receivership under the control of the FDIC. The Government liquidated the bank’s assets and sold them to JP Morgan Chase; all of WaMu’s local branches were re-branded as Chase banks. Thankfully, the FDIC insurance protecting depositors resulted in few people losing their money. Washington Mutual’s parent company eventually filed for bankruptcy and went out of business.
