What Happens When A Bank Fails?
Your money isn’t available. Yes, that’s right. It probably comes as a bit of a shock. Your banking app is down, too—that’s just a part of this whole thing. You read the message, though, right? I think it says something like, your financial services are not available. Not very helpful, is it? They should have given you more information. It’s not just that the app is down, but your entire bank is closed. Everything you’ve put into your accounts, all of your savings—that nest egg you put away for the basement renovation, and the money you earmarked for the trip to Kelowna to visit your sister and her family—that money is no longer there. What happened to it? Not sure. It’s too early to say, really. But it’s gone. Hey, remember that favorite restaurant of yours, the one with the green spinach fettuccini and those cute little ceramic cups and the back patio that was hidden away from the rest of the city? Remember how it went under and they just kind of closed their doors and left a note on the front window? This is just like that. Sometimes businesses fail, right? Well, sometimes financial institutions fail, too. Unfortunately, yours failed today. Your money is gone.
It’s hard to imagine hearing something like that, isn’t it? Without a doubt, it would be a little unnerving waking up one morning to the news that your financial institution is suddenly insolvent, and your life savings have somehow vanished overnight. But, strangely enough, that’s exactly what happened on June 4, 1996, when 2,600 Canadians woke up to the news that Security Home Mortgage Corporation based out of Calgary, Alberta, had failed. With it, $42 million in deposits and personal savings were up in the air.
So, what exactly happens to your savings when a Canadian bank fails?
What Is Deposit Insurance and How Does It Work?
When you put your money into a financial institution, you kind of expect it to be there when you need it. You don’t expect that your financial institution will lend that money out to so many defaulting borrowers that it drives itself into insolvency. After all, you’re handing your hard-earned cash over to a reputable financial institution—not an unreliable friend with money problems. (I’m looking at you, Jon.)
But despite all of the regulatory controls that help contribute to the stability of the Canadian financial system, bank failures can still happen. In fact, there have been 43 bank failures in Canada since 1970, but, incredibly enough, the majority of affected customers recovered all of their savings during each one of those failures. That’s because every one of those 43 financial institutions was covered by something called deposit insurance.
In Canada, Schedule I and Schedule II banks can accept deposits from the Canadian public, and each one of those institutions is required to be a member of the Canada Deposit Insurance Corporation (CDIC). The CDIC is a Crown corporation that was established by the federal government in 1967 and mandated to provide deposit insurance protection to each one of its member institutions.
It works like this. On the most basic level, banks and financial institutions do two things: They take money in, and they lend money out. In order to make a profit, they must ensure that they charge a higher interest rate on the money they lend out and a lower interest rate on the money they take in. This is called their spread. The model relies on two types of customers: borrower and depositors. The problem with this arrangement is that not all borrowers will pay back the money they’ve borrowed. Some of them will default. If too many of them default, the financial institution becomes insolvent.
On top of that, if a financial institution lends out the majority of its deposits and doesn’t have the money to pay back its depositors it can lead to something called a bank run. A bank run occurs when many clients withdraw all of their deposits and savings from a bank at the same time in fear that the bank may fail. This fear of insolvency can pick up momentum quickly and actually drive a struggling financial institution into insolvency.
Deposit insurance helps combat both of these issues. With a third-party offering to protect depositors’ money in the event of a bank failure, they can rest assured that their money is safe in the event a financial institution falls into insolvency. That promise also helps ensure that depositors won’t take their money out all at once and force a bank run.
What Is CDIC’s Fast Insurance Determination?
In order to ensure depositors get their money back quickly in the unlikely event of a bank failure, the CDIC requires all member financial institutions to adhere to their Fast Insurance Determination (FID) data and system requirements. The FID process ensures that CDIC can immediately step in and take control of a financial institution’s data within hours of a bank failure in order to extract important deposit and liability information. Following a bank failure, that deposit and liability information is loaded into the CDIC’s payout application, which organizes payout information and allows CDIC to make payments of insured deposits to depositors within just a matter of days.
The CDIC and its Fast Insurance Determination process play an important role in ensuring the stability of the financial system in Canada. It protects eligible deposits at each of its member financial institutions to a maximum of $100,000, in each of the following separately insured categories:
- Deposits in one name
- Joint deposits
- Deposits in trust (including RESPs)
- Deposits in TFSAs
- Deposits in RRSPs
- Deposits in RRIFs
- Mortgage tax accounts
Think of it this way. Maybe you’re not comfortable handing your money over to your unreliable friend. But if that unreliable friend had a reliable mom who promised to pay you back in the event that he couldn’t, you’d be a lot more comfortable handing your money over. CDIC is kind of like that reliable mom.
That reliable mom that shouldn’t have to do this for you again.
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