Can bank go bankrupt? Read on to learn more!

Can your banks become bankrupt? Discover now! Explore the reasons behind major bank failures and how they impact the economy.

• The Indian banking system remains relatively unaffected by crises.
• Stringent regulations and risk management in India ensure stability.
• Government bailouts prevent catastrophic impacts on financial stability.
• Bank failures decrease lending and hinder economic growth.

In the last few months, the world witnessed the downfall of major bank names, including Silicon Valley Bank, Signature Bank, and First Republic Bank. In fact, the failure of First Republic Bank was marked as the second-largest bank failure in U.S. history.

Contrary to the U.S., the Indian banking system has remained relatively unaffected, even during the collapse of Lehman Brothers in 2008. This is due to the stringent regulations and risk management practises implemented by the Reserve Bank of India (RBI), which ensure the stability of the banking sector in India. Though not bankrupt, Indian banks have witnessed their fair share of bank failures.

When a bank experiences a shortage of liquid funds, it undergoes a bank failure.

What are the reasons for bank failure?

Banking is a straightforward process: lend money at higher interest rates while borrowing at lower interest rates using deposited funds. However, the banking business is not as simple as it may seem. There are a lot of things that can go wrong with banks, such as bad loans, fraud, and mismanagement that breach bank security.

For example, when Yes Bank failed, the Reserve Bank of India (RBI) took over and superseded its management and issued a moratorium. Similarly, when Laxmi Vilas Bank failed, the RBI issued a moratorium and capped withdrawals. However, none of these banks went bankrupt. 

Also Read - What must Indians do to save themselves from a Silicon Valley Bank-type situation?

What are the reasons why banks don't go bankrupt?

Here are some reasons why banks don’t usually go bankrupt -

• Government bailouts

Banks play a vital role in the financial planning of the economy. To prevent a catastrophic impact on financial stability, governments step in to support troubled banks through bailouts. These interventions ensure that even banks marred by corruption and mismanagement do not fail, preserving the economy's backbone.

• Bail-ins

In some cases, rather than relying solely on government bailouts, banks implement bail-in strategies. This approach holds creditors and depositors partially accountable for the bank's losses. By sharing the burden, the need for government intervention can be reduced, thereby minimising the strain on public finances.

What is the impact of bank failure on the economy?

Bank failures have a significant impact on the economy. It leads to decreased lending, limited access to loans, reduced employment, slower product development, and hindered economic growth. Furthermore, it lowers investments, weakens financial markets, diminishes consumer demand, and adversely affects industries, ultimately impacting economic growth. Bank failures also erode consumer confidence, resulting in risk-averse financial behaviour, reduced spending, and a preference for storing cash. This contributes to demand-deficient unemployment, as firms struggle to afford additional employees and face decreased production due to low demand.

Furthermore, taxpayers bear the burden due to funds diverted from other essential areas of the economy.

Final thought

With prudent financial planning and effective risk management, banks can ensure a secure future!

Find the latest articles on financial planning here.

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