What You Need to Know About the Two US Bank Collapses in 2023

The recent 2023 financial collapse of two US banks has sent shockwaves throughout the financial industry. As a result, many investors are left wondering what led to the collapse and its implications on the broader economy.

Let us discuss the causes of bank failures and what you need to know to protect yourself as an investor.

What Does It Mean When a Bank Collapses?

A bank collapse occurs when a bank does not meet its financial obligations and cannot continue its operations. This can occur when a bank experiences significant financial losses, cannot pay its debts, or becomes insolvent.

For instance, the Signature Bank collapse was a result of concerns about depositors withdrawing large amounts of money after the Silicon Valley Bank collapse.

When a bank collapses, it may lead to a loss of customer deposits and loans, which can have ripple effects throughout the financial system.

The bank collapse in 2023 may lead to broader economic consequences, such as a decrease in consumer confidence and a slowdown in lending and economic growth. 

In some cases, governments may intervene to prevent bank collapses or to mitigate their impact, such as through bailouts or other financial assistance programmes.

What Are Some Reasons Behind Bank Failures?

There can be a variety of reasons for bank failures, some of which include:

1. Economic downturns: When there is a decline in the economy, it can lead to increased defaults on loans and a decrease in demand for credit, which can cause banks to suffer significant losses.
2. Mismanagement: Poor decision-making, lack of oversight, and inadequate risk management can all contribute to the failure of a bank.
3. Fraud and misconduct: Banks can fail when executives or employees engage in fraudulent or illegal activities,    such as embezzlement, insider trading, or money laundering.
4. External factors: Natural disasters, political unrest, or other unexpected events can harm a bank's operations and financial stability.
5. Insufficient capital: Banks need sufficient capital to cover potential losses to avoid becoming insolvent and failing.
6. Bad loans: Banks may suffer significant losses when borrowers default on their loans, mainly if they have made risky loans or have insufficient reserves to cover their losses.
7. Competition: Banks may only succeed if they can compete effectively with other banks. They may suffer in comparison because of a lack of resources, inadequate technology, or other factors.

What Happens During a Bank Failure?

During a bank failure, several things may happen, including:

1. Bank closure: When a bank fails, it may be closed by regulators, and its branches and operations will be shut down.
2. Deposit insurance: In many countries, including the US, deposit insurance programmes protect customers' deposits up to a certain amount in case of a bank failure.
3. Transfer of accounts: If a bank fails, its customer accounts may be transferred to another bank or financial institution, often through an acquisition or merger.
4. Loss of deposits: In some cases, depositors may lose some or all their deposits if they exceed the insured limit, which can have significant financial consequences.
5. Credit disruptions: The failure of a bank can disrupt credit markets and make it harder for individuals and businesses to obtain loans or credit.
6. Regulatory oversight: Regulators may investigate the causes of a bank's failure and prevent similar failures from occurring in the future.

The specific steps taken after a bank failure will depend on the circumstances and the country in which the bank is located.

How Bank Failures Can Impact the Wider Economy 

A bank failure can have significant impacts on the economy, including:

1. Economic growth: A bank failure can disrupt the flow of credit and investment leading to slower economic growth or even a recession.
2. Expensive loans: After a bank failure, surviving banks may become more cautious and increase their lending standards, making it more difficult and expensive for individuals and businesses to obtain loans.
3. Recession: Bank failures can contribute to economic recessions, as the loss of credit and investment can lead to decreased consumer spending, job losses, and a decline in business activity.
4. Smaller banks lend more: In some cases, smaller banks may step in to fill the lending gap left by the failure of a larger bank, leading to an increase in lending from these institutions.

These impacts can have far-reaching effects on the economy and the financial system, so regulators take bank failures very seriously and work to prevent them from occurring whenever possible.

What Was the Biggest Bank Failure?

The biggest bank failure in history occurred during the 2008 fiscal crisis when Washington Mutual (WaMu) collapsed. At its failure, WaMu was the most significant savings and loan association in the US, with over $300 billion (about $920 per person in the US) in assets and over 2,000 branches nationwide.

A series of factors, including risky lending practices, the bursting of the housing bubble, and a run on the bank by depositors, triggered the bank's collapse.

When WaMu failed, the Federal Deposit Insurance Corporation (FDIC) took over its operations and sold its assets to JPMorgan Chase.

The failure of WaMu was a significant event in the 2008 financial crisis, which had far-reaching effects on the global economy. It highlighted the risks of poor lending standards and the importance of strong regulatory oversight to prevent such failures from occurring in the future.

Overall, bank failures can severely affect the economy and financial system. The bank collapse in the US in 2023 underscores the importance of robust regulation and oversight to prevent such failures from occurring.

While the specific causes of these failures are unknown, history has shown that risky lending practices and inadequate risk management can contribute to bank failures.

The impacts of a bank failure can be significant, including slower economic growth, increased difficulty in obtaining loans, and even recessions.

It is essential for individuals and businesses to stay informed about the state of their banks and for regulators to remain vigilant to prevent future failures. To understand financial management better, you could consider to pursue a degree in finance and management.

The London School of Business and Finance (LSBF UK) offers a Master's in Finance and Investment that solidifies concepts in both theory and practice of financial decision-making. The programme lets you master the advanced level of financial skills needed to succeed in the industry. Enrolling in this course will help you learn how to make better financial choices.

Take the steps to start learning more about financial management today!