Bank insolvency is a situation where a bank is unable to meet its financial obligations and must either close or restructure to address the problem. European nations tend to use the term “insolvency” to describe situations where banks are failing, while in the United States, people may call it a “bank failure” or “bankruptcy.” Bank insolvencies are somewhat different from regular business insolvency because the collapse of the bank could cause significant financial problems for bank customers. As a result, regulatory agencies may be involved in the process.
Banks can become insolvent for a variety of reasons, ranging from failing to meet reserve requirements to having a high default rate on the debt they issue. Bank regulation has specific mandates in place to reduce the risk of bank failures and catch problems at banks early. If a bank suspects it has a cash flow or debt problem, it can be taken over by an administrator who will attempt to help the bank recover, negotiate a deal for a sale, or close the bank.
During bank insolvency proceedings, accounting logs are inspected to generate a list of bank creditors. Banks are typically insured and funds will be returned, up to a certain amount, to people who had money on deposit with the bank. To reduce consumer panic, the process is typically handled as quickly and quietly as possible; staff may move in during the weekend to take over a bank, for example, allowing it to open for business on Monday with minimal disruption.
Economic uncertainty tends to be accompanied with a rise in bank insolvencies. Under normal financial conditions, a handful of banks may fail in a given year. Once multiple large banks start to fail, a domino effect can occur, with smaller banks being dragged down as consumers start to panic and people fail to pay on their debts. In an economic climate where bank insolvency is a common problem, strike teams of regulators and government representatives may be developed in order to respond quickly to failing banks.
Regulatory agencies usually want to encourage banks to stay open by any means possible. In some cases, restructuring during a bank insolvency can allow a bank to reopen, and the bank will be monitored to confirm it is adhering to the terms of the restructuring. In other instances, a sale of the bank to another firm can be negotiated, with the firm taking on the debt obligations of the bank. Regulators usually offer a sweetener to the bank insolvency deal to encourage companies to buy failing banks and turn them around.