What happens if your bank or lender goes bust?

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on March 10, 2022
What happens if your bank or lender goes bust?

Have you ever wondered what would happen if your bank or lender went bankrupt?

The rise of non-bank lenders and in more recent times, neobanks, have had many people wondering exactly that because of the common misconception they aren’t as ‘safe’ as the big four banks.

Any time there's an economic shock, such as the Global Financial Crisis or the Covid pandemic, people are concerned about the stability of their bank. So what would happen if your bank or lender went belly up?

In this article...


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          How banks build their money

          To understand how a bank can collapse, you firstly need to understand how banks make money.

          At its most basic level, a bank lends out money (e.g. via home loans and car loans) at higher interest rates than the interest rates its pays on deposits (e.g. savings accounts and term deposits). So there is a gap between a bank’s interest earnings and interest costs.

          This is called the net interest margin or NIM, which is basically a measure of the difference between the interest income generated by the bank and the amount of interest paid out, relative to the amount of the bank’s interest-earning assets.

          Banks have many different sources of revenue - see below - but loans make up a big chunk of a bank’s interest-earning assets. Other ways include wholesale funding such as securitisation, and occasionally some help from the Reserve Bank.

          Banks typically become insolvent when the value of their liabilities outweighs the value of their assets, but this is incredibly rare in Australia.

          How could a bank go bust?

          There are two main ways a bank could go bust. Mass amounts of people would need to either default on their loans or pull their money out of the bank. Short of financial Armageddon, this is extremely unlikely to happen.

          1. Firstly, suppose a huge number of a banks' borrowers were suddenly unable to repay their loans. The bank could then be forced to write off those loans - which it would be reluctant to do because a bank’s loan portfolio is typically its primary asset. If enough bad loans are written off, the value of the bank’s assets could be worth less than its liabilities.
          2. Another way a bank could go under is if people panic and pull all their money out of the bank because they’re scared the bank could soon collapse. This is called a bank run and ironically, this fear usually becomes a self-fulfilling prophecy. Banks hold a certain amount of money in reserve for customer withdrawals but once this runs out and the bank is unable to raise additional cash or borrow from other banks, the only option might be to sell its loan book to another bank.

          One of the most recent Australian financial institutions to go belly-up in Australia was Queensland Permanent Building Society which suffered a bank run and closed its doors in 1977. Even in this extreme case, depositors were still repaid without any loss - largely thanks to a takeover from the State Government Insurance Office.

          Bank failures were much more prevalent in the United States during the Great Recession of 2007 to 2009. However, even in this extreme scenario, very few full-service banks were allowed to totally collapse. Many were either acquired by other banks, were bailed-out by the US Federal Reserve, or were forced to close before a bank run could happen.

          So now you know how a bank can go bankrupt, what happens to your money if your bank were to somehow fail?

          What happens to your savings if your bank collapses?

          If you’re worried your Australian bank will go bust one day, you don’t need to withdraw all your money and bury it in the backyard because the government will make sure you get your money back - up to a certain amount.

          The Australian Government guarantees customer deposits up to $250,000 with Authorised Deposit-Taking Institutions (ADIs) under the Financial Claims Scheme (FCS).

          The FCS was born out of the Global Financial Crisis (GFC) to boost confidence in the banking system and the security of people’s money.

          For a hot minute the FCS covered up to $1 million in deposits, but was later reduced to $250,000.

          At the time of writing, there have been no claims under the FCS, so it remains to be seen how deposits are returned to customers in real-world scenarios, and how long this claims process could take.

          APRA Financial Claims Scheme Explained

          Under the FCS, if you have up to $250,000 in your savings account, you will receive all of that money back in the event that the bank collapses (provided that your bank is on this list of ADIs). However, if you have more than $250,000 in deposits with the one bank you won’t be guaranteed to get it all back.

          For example, if you have $460,000 in a savings account, you are guaranteed to get $250,000 back but could lose the remaining $210,000 if banking Armageddon happened.

          The scheme is capped at one person per financial institution, but you can get the guarantee with as many financial institutions as you like. So you could put $250,000 with Bank A and the remaining $210,000 with Bank B and be 100% guaranteed for both amounts.

          It’s worth noting that multiple banks may be under the same ADI. So if you have $250,000 with Bank A and $250,000 with Bank B but they’re both under the same ADI, then you will only be guaranteed for the first $250,000 - not $500,000.

          It’s also important to note that in the case of joint bank accounts, the $250,000 guarantee individually applies to each account holder. If you and your partner share a joint account with $500,000 in it, you would both be individually guaranteed up to $250,000 of your share.

          The government guarantee applies to all customer deposits with a licensed bank, so that includes funds in savings accounts, transaction accounts, term deposits and offset accounts.

          The FCS also applies to credit unions and building societies.

          If you’re still unsure your money will be covered, the Australian Prudential Regulation Authority (APRA) has a handy deposit checker on its website.

          Depositor preference

          Beyond the FCS that protects amounts up to the $250,000 cap, there’s another level of protection that covers all deposits (not just amounts under the $250k cap) called ‘depositor preference’.

          According to the RBA: “Deposits above the cap in Australian ADIs also benefit from depositor preference. This means that Australian depositors have a priority claim on the assets of a failed ADI ahead of other unsecured creditors, after the Government has been reimbursed for any amounts paid under, and expenses incurred in relation to, the FCS”.

          Essentially, this means that if an Australian bank collapses, APRA (on behalf of the Government) gets first preference over the bank’s assets to recover amounts paid out to depositors under the FCS (the $250,000 guarantee) and other expenses incurred in operating the FCS.

          After APRA, the failed bank’s remaining assets in Australia must then be used to repay any deposits in Australia above the $250,000 cap before they can be used to repay other unsecured creditors.

          Bankrun.jpg

          Pictured: A bank run in the UK in 2007. Image by Lee Jordan via Flickr.

          What happens to your mortgage if your bank or lender goes bust?

          Sadly, you don’t get a free pass on your mortgage or a free house (but we can dream).

          If your lender went bust, the most likely outcome is that your mortgage would get sold to another lender. The terms of your mortgage contract are unlikely to change because only your repayments are being given to another financial institution. Essentially, you keep calm and carry on making your mortgage repayments.

          Once your mortgage has been sold to another lender, the interest rate could move up or down depending on how the new lender sets their rates.

          If your lender were to go bankrupt, they can’t 'call up’ your mortgage - meaning they can’t ask you to pay the remainder of your loan in full.

          What happens to the money in your redraw facility?

          The government guarantee does not cover redraw facilities - whether your lender is an ADI or not. So it doesn’t really matter if you’re with a big four bank or an online non-bank lender - the government guarantee does not apply to redraw facilities, full stop.

          However, if your lender were to go bust, any extra mortgage repayments you have put into the redraw facility would be deducted from the amount you owe the lender. So, your outstanding loan balance would effectively be reduced and your net position would not be impacted.

          On the other hand, mortgage offset accounts are covered under the $250,000 government guarantee.

          Don’t know the difference between a mortgage offset and a redraw facility? While they are similar, a mortgage offset account is pretty much like a transaction account - the money in which is ‘offset’ against the home loan debt, reducing the interest costs. Meanwhile, a redraw facility is a home loan feature that allows you to redraw extra repayments you’ve made on your home loan.

          Are non-bank lenders and neobanks safe?

          Contrary to what some people may think, non-bank lenders and neobanks are generally just as safe as any of the major banks because all are bound by strict regulations.

          The newcomer to the banking block, neobanks have to obtain a full ADI license from APRA before accepting money from customers. So stashing your money into a savings account offered by a neobank is no riskier than depositing your money in a savings account with a big four bank.

          While non-bank lenders may not be ADIs, this doesn’t mean these institutions are not safe to borrow from. Non-bank lenders are still governed by the Australian Securities and Investments Commission (ASIC) and bound by the National Consumer Credit Protection Act (NCCP) and Australian consumer law.

          Because they have lent you money, you have their money and assuming you have a standard mortgage, they cannot ask you to pay up the rest of your loan if they went bankrupt. Just like a bank, a non-bank lender can only ask you to continue making your normal mortgage repayments.

          Some people claim that because non-bank lenders are smaller, they’re more vulnerable than bigger banks during unstable economic times and would be more likely to raise interest rates. Recent history suggests this is not the case, with many non-bank lenders currently offering far more competitive interest rates than the bigger banks, and possessing market capitalisations as big as some banks with household names.

          In Australia, all legitimate banks and lenders must hold an Australian Credit License (ACL) from ASIC or an Australian Financial Services License (AFSL). Banks and lenders (and finance websites like this one) must display the numbers of these ACL or AFSL licences (it’s usually found at the very bottom of a website). If you scroll down to the bottom of this website, for example, you’ll see Savings.com.au’s AFSL and ACL number:

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          If you’re unsure the company you’re dealing with is legitimate or not, MoneySmart has compiled a list of unlicensed companies that should be avoided.

          Xinja - the latest example of an Australian bank 'collapse'?

          Xinja was a neobank and was granted a full banking licence in 2019. In 2020 it had one of the highest savings account interest rates in the market. It quickly ran up the flagpole in terms of customer deposits, reaching $200 million in a matter of months. 

          And that right there spelled problems. It did not have any sort of loan product charging interest to compensate, so the bank was burning cash hand-over-fist in interest-paid on customer deposits. 

          Not even a mysterious $400 million injection from Dubai-based 'World Investments' could save the faltering neobank.

          In October 2020, it cut its savings account rate; in November it cut its maximum interest rate deposit limit by two thirds; and by December it announced it would return all customer deposits and give up its banking licence.

          The case of Xinja was not technically a bank failure, because it returned all deposits and APRA did not need to intervene with its Financial Claims Scheme.

          However, the disappearance of a plucky neobank was noticed in the wider banking landscape; APRA chairman Wayne Byres called it a 'successful failure', according to AFR reports.

          APRA has since made it more onerous to obtain a banking licence, with would-be banks required to prove sustainability rather than short-term profitability. 

          Savings.com.au’s two cents

          While it’s highly unlikely that a bank or lender will go bankrupt in Australia, it has happened in other parts of the world so it’s important to know what would happen if a bank were to go bankrupt here.

          The good news is that there’s no need to panic. Your deposits would be protected under the government guarantee up to a limit of $250,000 and you would receive that money back almost instantly.

          If you have more than $250,000 stashed away, it may be wise to spread out that money across multiple banks so that all your hard-earned savings will be protected - just check they are not covered by the same ADI otherwise your efforts will be null and void.

          Those with a mortgage don’t need to worry either as the loan would likely be sold to another lender, so you would carry on making your mortgage repayments as usual. You wouldn’t lose your house, and your lender can’t ask you to pay the remainder of your loan.

          Article first published 18 March 2020, last updated 10 March 2022.


          Photo by Andrea Piacquadio from Pexels

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          author-avatar
          Emma Duffy is Assistant Editor at Your Mortgage and  Your Investment Property Mag, which are part of the Savings Media Group. In this role, she manages a team of journalists and expert contributors committed to keeping readers informed about the latest home loan and finance news and trends, as well as providing in-depth property guides. She is also a finance journalist at Savings.com.au which she joined shortly after its launch in early 2019. Emma has a Bachelor in Journalism and has been published in several other publications and been featured on radio.

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