Bank failures can have devastating effects on economies across the globe. Though the number of failed banks in the United States has been relatively low in the past decade or so, it is becoming increasingly difficult to ignore the risk potential that they pose to global growth. This article will discuss the history of U.S. bank failures, the causes of them, the potential impact they can have, and some potential solutions to reduce the risk.

History of U.S. Bank Failures
Since the passage of the Federal Deposit Insurance Corporation (FDIC) in 1933, the number of bank failures in the United States has been drastically reduced. The agency insures deposits of up to $250,000 and has worked to protect customer’s deposits from bank failures.

From 1933 to 2009, the FDIC reported a total of 800 failures, the majority of which occurred during the Great Depression. Since then, the number of failed banks has remained relatively low, with just two failures in 2019 and none reported so far in 2020.

The Causes of U.S. Bank Failures
Though the number of bank failures in the U.S. has been relatively low, there are still numerous causes of bank failures. Some of the more common causes include inadequate capitalization, poor asset management, irregular accounting practices, interest rate risk, operating losses, and fraud.

  1. Inadequate Capitalization
    Inadequate capitalization occurs when a bank’s capital is insufficient relative to the size of its assets or the risk of its loans. Over time, inadequate capitalization can lead to increased risk-taking by the bank, with potentially damaging consequences.

  2. Poor Asset Management
    Poor asset management refers to a bank’s mismanagement of its investments, such as real estate and other fixed income securities. If a bank fails to properly manage its assets, it can lead to decreased profitability and an inability to meet its obligations.

  3. Irregular Accounting Practices
    Irregular accounting practices can occur when a bank fails to properly record and track its financial statements. This can lead to a wide range of issues, ranging from inaccurate financial statements to fraudulent activities.

  4. Interest Rate Risk
    Interest rate risk occurs when a bank has too much of its assets invested in interest-sensitive assets, such as mortgages and Treasury bonds. If interest rates rise, these assets can become more risky and can lead to losses for the bank.

  5. Operating Losses
    Operating losses are losses incurred from normal day-to-day business operations. These losses can occur due to decreased demand, increased competition, and inefficient operations.

  6. Fraud
    Fraud is when employees or lenders of a bank fraudulently manipulate the bank’s books in order to gain personal or corporate gain. This can often be difficult to detect and can have severe consequences for the bank if left unchecked.

Potential Impact of U.S. Bank Failures
While the number of bank failures in the U.S. has remained relatively low, it is important to recognize the potential impact that they can have on the global economy. Bank failures can lead to decreased lending, reduced savings, increased unemployment, and decreased investment.

Decreased Lending
Bank failures can lead to a decrease in the amount of lending that is available, which can slow economic growth and make it more difficult for people to access credit. This can be especially detrimental to small businesses, which rely heavily on bank loans to operate.

Reduced Savings
When banks fail, customers can lose their savings, creating financial hardship for individuals and families. This can also cause economic instability in the broader economy as individuals are unable to save for retirement or other long-term costs.

Increased Unemployment
Bank failures can lead to increased unemployment, as banks are forced to lay off employees in order to cut costs. This can lead to decreased consumer spending, which can further contribute to a decrease in economic growth.

Decreased Investment
Bank failures can also lead to a decrease in investment, as investors become hesitant to put money into banks that may not be able to return their capital. This can lead to fewer business start-ups, decreased job creation, and decreased economic productivity.

Possible Solutions to Reduce Risk
Though bank failures can have a significant impact on global growth, there are steps that can be taken to reduce their risk.

Regulatory Oversight
One way to reduce the risk of bank failures is to ensure that all banks are adequately regulated. This can involve increased oversight of banking activities, as well as assessing the banks’ risk management practices to ensure they are sound.

Increase Capital Requirements
Another way to reduce the risk of bank failures is to increase the amount of capital that banks must hold. This would provide banks with a larger cushion to absorb potential losses, reducing their risk of failure.

Increased Transparency
Ensuring that banks are transparent about their activities is another way to reduce the risk of bank failure. This could involve increased disclosure and regular audits to ensure that banks are adhering to correct banking practices.

Though the number of U.S. bank failures has remained relatively low in recent years, the potential impacts that they can have on the global economy remains high. To reduce the risk of future bank failures, it is important that banks are adequately regulated, that capital requirements are increased, and that increased transparency is enforced.