Could financial institutions like Bank of America or Citibank go bankrupt?

Written by J. Hirby and Fact Checked by The Law Dictionary Staff  

Banks in the United States are created by means of federal and state charters, but they are ultimately controlled by business entities that have certain obligations to creditors. Just like other businesses, banks can go into the red and run out of funds to meet their obligations. Instead of calling it a bankruptcy, however, financial regulators call it a failure.

When banks become insolvent, they pose a risk to their depositors and account holders. For this reason, the Federal Deposit Insurance Corporation (FDIC) stands ready to intervene and guarantee the funds of individual depositors up to $250,000 in case their banks are compromised by limited liquidity.

Major banks such as Bank of America and Citibank can become insolvent and fail. Recent history shows that financial institutions such as the former Washington Mutual, IndyMac, Colonial Bank, Wachovia, and others are prone to failure when their capital ratio levels are too low. This means that troubled banks are likely to fall into a such a precarious state that they are unable meet their obligations from one day to the other.

Causes of Bank Failures

Failures can occur during periods of significant financial turmoil such as the collapse of the U.S. housing market and the credit crunch of 2008. There is also the dreaded bank run, which consists of a large number of account holders withdrawing funds from their accounts or closing them at the same time.

An example of a bank run that contributed to the demise of a large financial institution occurred in September 2008. In just nine days, Washington Mutual (WaMu) account holders concerned about the bank?s mounting losses from its subprime mortgage losses took out more than $16 billion, which was nearly 10 percent of total deposits at the time. WaMu was eventually taken over by officers from the U.S. Office of Thrift Supervision (OTS) and sold to JPMorgan Chase.

Like other businesses, banks hold assets and carry liabilities. The market value of a bank?s assets against the financial burden of its liabilities determines its ability to issue loans and make deposits available to account holders. In the case of banks such as WaMu, IndyMac and Florida?s BankUnited, their troubled asset ratio was too high to sustain normal operations. This was caused by the sudden drop of market value of the subprime mortgages those institutions originated at the height of the American housing bonanza of the early 21st century.

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