Thus far, four U.S.-based bank failures have been rescued by the FDIC in 2023. That's the highest total since 2019, and it's about on pace for a full year's failure rate not seen since 2017.
For those with money in a failed bank, it can be quite unnerving. Even worse, when one bank fails, it often causes people to worry about other banks, which could lead to a run on their deposits and yet another failure.
Yet, for most of us, it's really hard to tell in advance when a bank is going to outright fail. Indeed, according to research from the New York Federal Reserve, there's often very little difference in how ordinary depositors behave at a failing bank versus one surviving. As a result, it's important to recognize that while you can't control bank failures, you can control what you do about them.
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First, know your deposits are likely protected
As long as your bank and account type are covered by the Federal Deposit Insurance Corporation (FDIC), you're protected for at least the first $250,000 of deposits.If you have more than $250,000 in cash and CDs and similar account types in the bank, you can extend your insurance by splitting that money up across different banks. You can also extend your insurance by having joint ownership of accounts -- such as with a spouse.
In addition, the FDIC may cover deposits above that $250,000 protection level, as it did when Silicon Valley Bank failed earlier in 2023.
As a result of that FDIC insurance, it's important to recognize that investors in a failing bank are much more likely to feel the pain of a closed bank than its depositors will.
Invest with eyes wide open
Because it's often difficult to tell from the outside when a bank will fail, and because investors will feel the brunt of any bank failure, it's important to invest in banks with your eyes wide open. First and foremost, recognize that portfolio diversification can reduce the impact on your overall financial condition from the failure of any one company you own.
For instance, if the only stock you own is a bank that fails, you could lose 100% of your invested capital. On the other hand, if that same bank is only one of around 20 similarly sized different investments you have, its failure will only cost you around 5% of your invested capital.
In the first situation, your total losses could be absolutely devastating. In the second one, while it's still painful, it's also manageable. Indeed, if the market provides returns near its historical long-run average of around 10% annually, you could potentially even make up for that second loss in less than a year.
On top of the importance of diversification, there are a few things you can look at when it comes to the unique risks of investing in a bank. One key measure is its Tier 1 Capital Ratio. That ratio measures the level of a bank's core capital available to cover losses from non-payments from assets it holds, like mortgages or business or personal loans.
The higher that ratio, the better the bank's ability to handle losses and the lower its risk of failing. Among big banks, JP Morgan Chase has a Tier 1 Capital Ratio of 17, and both Wells Fargo and US Bank have ratios of around 12.5. All three of those banks' ratios are well above the minimums set by the Federal Reserve.
Get started now
Although you can't control -- or even perfectly predict -- bank failures, you can do something about them. By keeping your deposits below FDIC maximums, diversifying your portfolio, and looking for healthy capital ratios among banks you are investing in, you can set yourself up for a better chance of success.
Since it's so difficult to see many bank failures coming before they hit, now is a great time to get yourself ready in case the next one is just around the corner. Make today the day you start preparing and have one less thing to be overly concerned about should you find yourself with a failed bank on your hands.
