Your bank’s financial health matters… a lot.
But unfortunately, most people don’t have a clue how to determine whether a bank is financially sound or heading straight off a cliff.
In this article, we’re going to help you identify the signs of a troubled bank and navigate your options for protecting yourself, your business, your employees, and your investors.
KEY TAKEAWAYS
- Bank failures result from the compounding effect of bad decisions over long periods
- There are clear (publicly visible) warning signs that anyone interested can see
- Most people don’t take the time to understand or monitor these warning signs
- Depositors need to take responsibility: choose financially sound & well-managed banks
In short, if you keep money at a troubled bank you should be worried. If that bank fails, you (and your deposit) are caught in a mess. And getting out of it is a nerve-racking and drawn-out experience.
Getting your money back can be painfully expensive and inconvenient. And, you’re often left financially stranded, without any support, forced to sort it all out on your own.
That’s why you need to know what to look out for before a bank fails.
Feel free to use the table of contents to jump ahead to the sections most relevant to you.
Table of Contents
- You Can Protect Your Deposits
- The Mechanics of a Bank Failure
- Warning Signs Before a Bank Fails
- How to Protect Yourself Before Trouble Strikes
You Can Protect Your Deposits
You can protect yourself from bank failures and bail-ins. But you need to know what to watch out for and when to act.
Withdrawing your money before a bank fails is your last chance to protect your deposits before it’s too late.
To do this, you need to recognize the early warning signs of a troubled bank. If you know which distress signals to look for, you can find out when something is wrong. Then, you can move your money to a safer bank before it’s too late.
In most cases, these warning signs start to appear months (or even years) before a bank is in the final stage of failure. If you wait until this final stage, you might still be able to get your money out… but you might not.
Below are 12 warning signs to watch out for. You can use them to spot troubled banks and find out if your bank (and your money) is in danger.
Remember: These may be the only clues you’ll get before a bank goes bust.
Before diving in, if this is your first time visiting GlobalBanks, don’t forget to download your FREE Non-Resident Banking Starter Guide. It’s designed to help non-residents open an international bank account in top banking hubs around the world.
Mechanics of a Bank Failure
The actions you take before a bank fails are important. But, not surprisingly, most depositors either miss the warning signs or don’t know what to look for. And as a result, they don’t see trouble coming.
Most people think that if a bank has deposit insurance, they don’t need to worry about bank failures. But that’s completely wrong. This is a false sense of security.
The truth is, keeping money at an unhealthy bank is dangerous, expensive, and painfully inconvenient. And that’s true whether it’s covered by deposit insurance or not.
Limitations of Deposit Insurance
Whether you bank in the United States, United Arab Emirates, Canada, European Union, United Kingdom, Isle of Man, Jersey, or any other country that offers deposit insurance schemes in place, you still need to prepare for a bank failure.
Here’s why…
In most cases, deposit insurance only covers up to a specific threshold of deposits. Beyond that level, depositors typically need to wait for bank assets to be sold before they recoup any losses.
But, even if your deposits are below the insured threshold, you may still need to wait for days (or weeks) before you can recoup your funds. And if that was your only bank account, it can take several weeks to open a new account in order to receive those funds. In the interim, you’re left with no access to capital to pay bills, expenses, vendors, employees, etc.
With this in mind, having a portfolio of diversified bank accounts and understanding the health of your banks is critical.
While this may seem like a lot of work, it should be part of any business’ basic financial management practices and there is no excuse not to monitor these very basic signs.
Here is a closer look at the fallout that can result from a bank failure even if your funds are held at banks covered by deposit insurance.
You Can’t Access Your Money
If your bank is under investigation, facing legal trouble, or liquidation, the bank will likely freeze all customer accounts and stop all services. Your money is frozen and can be locked up for weeks, months, or even years. This is true whether a bank is covered by deposit insurance or not.
Financially Stranded
If your account is frozen, you can’t make transfers or use that money to pay for bills and life necessities. This is expensive and incredibly inconvenient. You’ll need to find another source of funds to pay your bills. If this account was your only source of funds, you’re left financially stranded. And, if you can’t make loan or credit card payments because all your funds are tied up, you’ll be forced to pay penalty fees, and exorbitant interest payments and your credit history will suffer.
Urgent Need to Open a New Account
One of the most practical and immediate concerns facing anyone in a bank failure is opening another bank account. Unfortunately, opening accounts does not happen overnight. But, during a failure, you will need to urgently find and open a new account at a new bank.
Loss of Deposits
One of the biggest risks of a bank failure is loss of funds. This is true whether you bank with an insured or uninsured bank. Importantly, regardless of whether a bank is covered by deposit insurance, you still need to know the state of your bank’s financial health.
But even if your bank has deposit insurance, you can still lose your money. For example, if the country has bail-in legislation, depositors risk getting repaid in bank equity instead of cash.
Or, you could lose money if your bank fails and your money isn’t deposited in the “right” products. Only funds deposited in certain products and currencies will be reimbursed by deposit insurance.
Blacklisted & Can’t Open Other Accounts
If your bank does something fraudulent, or illicit, or gets in trouble for money laundering, or its reputation is tainted due to a public scandal, YOU can get hurt too.
If your bank goes bust and closes your account, you’ll need to rush to open an account elsewhere and transfer your money to the new institution.
The trouble is, other banks might blacklist you by association with the last bank. Some will refuse to open accounts. If they do open accounts, they might refuse to accept transfers from the failed bank.
Why? Too much stigma, scrutiny, and risk. Especially if your previous bank failed due to compliance failures and had a reputation for attracting unsavory clients.
This is typically an issue with international banks that cater to high-risk clients and have loose onboarding policies, which we have stressed elsewhere should always be avoided.
Warning Signs Before a Bank Fails
What happens before a bank goes bust? Here are some early warning signs to watch out for. Use these to spot trouble ahead and protect yourself from bank frauds and failures.
Poor Financial Outlook
Before a bank fails, it will typically show signs of financial trouble in its financial reporting for months (in some cases years) before the public takes notice and regulators step in. This is a huge opportunity for any depositors willing to take a look, it means you can get your deposits out before anyone else and protect your funds before there’s a tangible problem.
Financial Indicators to Monitor
The top-line financial indicators to monitor as a depositor at a bank are solvency and liquidity.
Bank Solvency
If a bank is solvent, it has a reasonable amount of funds available to cover its depositors and creditors if some of its assets go bad.
To calculate a bank’s solvency ratio you simply divide a bank’s total equity by its total assets. You want to see a solvency ratio of at least 10%. Higher is better.
Liquidity
In addition to solvency, you also want to monitor your bank’s liquidity, as expressed through the amount of depositor money the bank keeps in cash and other liquid investments.
This is one of the most important indicators of a bank’s health. It reflects a bank’s ability to withstand any major withdrawal demands from depositors, also known as a “run” on the bank.
In other words, the bank should have enough cash and cash-like investments to cover short-term demands from depositors. To calculate a bank’s liquidity, simply divide the total cash and cash-like assets by the total deposits due to customers.
Again, we like to see at least 10% of all deposits kept in cash and cash-like assets, though this should be looked at in conjunction with solvency. And, like the solvency ratio, higher is better when it comes to liquidity.
Please note: Depending on the country where your accounts are located, regulators will likely not require these levels of solvency or liquidity from their banks. Instead, they require very low levels of capital in order to protect the bank from normal operating risks.
In our view, the regulatory requirements imposed on banks are insufficient and lead to significant financial risk when economic cycles start to unwind. In short, these requirements reflect how fast the domestic government wants an economy to grow (e.g. reduce capital and lend more) or slow (e.g. increase capital and restrict lending).
If you would like to read more about how to know if your funds are safe during uncertain economic times you can read our dedicated article on the topic here.
Delayed Financial Reporting
If you missed the signs leading up to bank trouble, this one should shock you into action…
In many cases, before regulators step in to try and save a bank, the bank makes a statement informing the public that they will be delaying upcoming financial reports. This delay can be days, weeks, or (in the end) may never come.
When delayed reporting is announced, you are usually already in the end game. It means the bank’s management team is trying to find a way out of its current situation, navigate a liquidity crunch, meet creditor demands, and confirm that the bank is able to continue operating. Whatever the case may be, there is no good reason for a bank to delay reporting its financials. Bank management knows the implications of doing this, and so should depositors.
Why Banks Delay Financials
Bank management may be dealing with an extreme or unexpected change in the valuation of certain assets, an unexpected rise in customer withdrawals, trying to decide how to present poor financials to the market, or determining how best to deal with the fallout after a bad situation becomes public. There are countless reasons for a delay in reporting. It’s possible that not all of them are critical to the going concern of a bank.
Less Obvious Signs to Watch For
There are a number of other signs that can indicate that a bank is in trouble (or trying to avoid trouble). Most of these apply to smaller banks in less developed banking sectors. However, a few of these are also relevant for large banks in jurisdictions like the United States, the European Union, and the UK.
A Sharp Decline in Customer Service
Banks that are trying to avoid failure usually resort to extreme short-term measures to attempt to correct their path. This usually means aggressive cost-cutting, which involves the termination of “non-essential” staff. One sign of this that depositors may notice is a dramatic decline in the quality (and availability) of customer service.
In practice, the bank might terminate staff, cut employee compensation, cut entire divisions, or reduce support to them. All of sudden, it takes 10 days to get an email response, it’s impossible to get phone support, and technical support is non-existent.
When dealing with large publicly listed financial institutions, you won’t have to look far for this information. Major bank layoffs will be shared across news outlets, and you will have a hard time avoiding the information. Smaller banks that are not publicly traded are not obligated to share this information. So, you’ll need to keep an eye out for such changes if you bank with these institutions.
Restricted Transaction Activity & Currencies
Before a bank goes bust or experiences financial trouble, it might discontinue, limit, or restrict certain transaction activity. For example, no more outgoing transfers in certain currencies or limits on the number (and value) of outgoing transfers that customers can make per day.
In addition to indicating that there may be issues with a banks overall financial health, it can also indicate that a bank may be having challenges keeping correspondent bank relationships. This will become apparent if the bank updates you with new correspondent bank details for international transfers.
When this happens, depositors should compare the new correspondent to the past correspondent. Did the bank upgrade or downgrade its correspondent bank relationship? For example, did the bank previously have a small regional bank facilitating transfers and now they’re using a large international bank? Or, did they move in the opposite direction?
Banks do not restrict or limit transaction activity unless there are problems. So, if this happens, you should be looking to move your funds to safety. That said, if you look for the signs first shared above and take appropriate actions, your money should be out of the bank before this happens.
Abnormally Aggressive Marketing Tactics
Healthy banks are always proactively attracting new business and regularly advertising. But it’s when advertising ramps up to extreme levels, this could indicate the bank is dealing with financial problems.
Depositors should be especially careful when they see a wide range of different non-discerning sources (e.g. bloggers, influencers, and affiliate marketers) promoting opening accounts at a particular bank at the same time.
In most cases, these non-banking influencers are being paid an affiliate commission for every account they direct to the bank. The problem is they have no basis for determining whether opening an account with a particular bank is good or bad. And, not surprisingly, the banks know this.
To be clear, we’re not saying that banks should not promote their services through different channels. In fact, we see nothing wrong with banks promoting revenue-oriented products like credit cards or international transfer services. But, aggressive tactics to attract deposit accounts can certainly be an indication that the bank is trying to quickly raise (or diversify) its deposit base.
Account Opening Becomes Abnormally Easy
When banks start accepting anyone as a client and account opening becomes abnormally easy, it’s time to consider opening accounts elsewhere. Similar to aggressive marketing, it can indicate that a bank is trying to insulate its balance sheet. Essentially, the mindset is to get deposits now and deal with compliance later.
Interestingly, this is a similar approach that most fintech and digital banking options rely on when trying to scale their platforms. And, it’s why two to three years after launching there is usually a mass wave of customer account closures being reported.
In addition to beefing up a bank’s balance sheet, sidelining critical compliance elements can also result in negative attention from domestic regulators, international regulators, and correspondent banks. These are not groups that you want mad at your bank. They can shut down operations, turn off access to international currencies, and freeze bank (and depositor) assets while conducting investigations. So, if you notice that your bank is starting to aggressively onboard clients from less savory backgrounds, it may be time to bank elsewhere.
Bank Stops Accepting US Dollars (or Other Major Currencies)
This is a classic sign of distress for international banks. What typically happens is the bank will announce to clients that they can no longer hold or transfer US dollars starting on a certain date. And if the client continues banking with the bank, they will need to do so in a non-USD currency.
This suggests that the bank has either lost its US dollar correspondent banking relationship(s) or doesn’t want to attract scrutiny for future US dollar transactions. When this happens, you need to be thinking about whether there are better banking options available to you. And to be clear, there almost always are.
Additionally, when this happens you should also pay close attention to the correspondents facilitating transfers for other currencies, which we’ll discuss next.
Loss of Correspondent Bank Relationships
If a bank loses reputable correspondent bank relationships like JP Morgan Chase or Commerzbank and then starts using Western Union (or a non-banking institution or money transfer service), this is not a good sign and indicates a larger problem.
Similar to losing USD correspondents, you need to know whether your bank has decent correspondent banking relationships for all major currencies that they offer. This will tell you whether or not other banks trust and want to do business with your bank.
That said, it’s common for smaller banks located in the Caribbean, Central America, and parts of Europe to use medium-sized national banks from the United States, Europe, and the United Kingdom to facilitate transfers in their respective currencies. This is not an issue as long as those relationships are stable.
But, if your bank is constantly changing correspondents then this is indicative of underlying issues that you may want to avoid.
Please note: In certain instances, banks may lose correspondent relationships due to their jurisdiction of operation and at no fault of their own. We’ve seen this happen in places like the Cook Islands, Nevis, Saint Vincent and the Grenadines, Panama, and elsewhere. In other words, banks that are located in countries with bad press or negative international regulatory sentiment can face correspondent bank issues more often than elsewhere, even when their financials and operations are strong.
How to Protect Yourself Before Trouble Hits
The examples above are indicators of bank distress. When a bank has multiple distress signals over a period of time, it can indicate a larger problem. And for depositors, this can signal that it’s time to move their money and switch banks.
If you’re worried that your bank may be in financial trouble and want to start exploring your options, you can get started by using the information in this article.
But if you need more help or want to know the best ways to protect yourself and your money, then we’d be happy to help you on your journey.
If you’re ready to take action and start opening international accounts now, you can access GlobalBanks IQ, our dedicated international banking intelligence platform.
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