How safe are online banks from collapse?

However, that isn’t always the case. 

The long-term security of these institutions isn’t inherent. Its credibility and security lies in the hands of the decision makers who are running these institutions and make key decisions about how much risk to assume, underwriting standards, and more.

This year, many consumers experienced a bank failure firsthand—leaving many to scramble to find a new place to park their funds. But how can you be sure that your money is actually safe? And in an age of digital banking and fintechs, are certain types of institutions more prone to collapse than others? 

2023 Bank failures—explained 

A bank failure is defined as the closing of a bank by a federal or state banking regulatory agency. This typically happens when a bank is unable to meet its obligations to depositors and others.

In recent months, a series of bank failures at the regional and national level have cast a spotlight on the fragility of the banking sector, but history indicates that this isn’t a new phenomenon. In the past decade, there have been over 70 bank failures in the U.S. The newest additions to that list include Silicon Valley Bank, Signature Bank, and most recently, First Republic Bank. 

For many consumers, this may be the first time they’re hearing about bank collapses and realizing that it is possible for their bank to fail them. And for those who opt for a more modern financial institution like an online bank or fintech, there may be an added layer of concern about the fate of their funds in the event of a collapse. 

What makes online banks and fintechs different from regular banks?

A neobank or fintech company offers banking services or accounts through online or mobile platforms. These platforms aren’t usually regulated in the same way that traditional financial institutions are. Unlike traditional banks, neobanks are often not banks and therefore do not have a bank charter with state or federal regulators. Instead, they often partner with an already regulated entity so that their deposits will be insured by the FDIC. 

Online banks are usually online divisions of brick-and-mortar banks and any insurance that covers its parent bank will extend to its online subsidiary as well. What’s more—opting for an online bank or fintech offers several perks like lower costs, greater accessibility, and sometimes even more lucrative rewards because these types of platforms and institutions don’t face the same overhead costs as traditional banks.

Are online banks safe?

The short answer: Digital banks are not any more or less prone to collapse than traditional banks. Experts say that as long as your deposits are federally-insured and the funds in your deposit account fall below the maximum coverage limit, you can rest well at night.

It may also be worth your while to do some digging and carefully comb through publicly available information to look for any potential red flags that could be key indicators of a bank’s financial health. This could include:

• Solvency: A bank’s solvency tells you if that institution has enough assets to pay its depositors and creditors and continue operations. You might think about this as your bank’s net worth—its assets, minus its liabilities.
• Liquidity: A bank’s liquidity is its ability to meet all of its customer’s needs and cover withdrawal demand. Having enough cash and liquid investments helps the bank avoid a potential “run” or default as a result of increased withdrawal demand and lack of reserves.

However, there is no tried and true way to predict a bank failure. You can, however, ensure that your deposits are protected.

“There are a number of reasons why a bank could potentially fail. The most recent wave of collapses was caused by poor management and a classic run on the banks. The good news is that you absolutely can safeguard and protect your life’s savings,”  says Ben McLaughlin, president of SaveBetter, an online savings platform. “The most important thing to verify is that the online bank is FDIC insured. As long as the institution is federally insured and savers keep within the guidelines, your money is safe even in the event of a bank collapse.”

The Federal Deposit Insurance Corporation (FDIC) is an independent agency that was created by Congress in the 1930s as a means of building trust and confidence in the banking industry in response to a string of bank failures. Both online banks and credit unions will typically offer some sort of insurance for deposit products in case the institution fails. For banks, the Federal Deposit Insurance Corporation (FDIC) will offer insurance coverage up to $250,000 per depositor, per bank, for each account ownership category. 

When a bank collapses, the FDIC sells and collects the assets of the failed bank and settles its debts, including claims for deposits in excess of the insured limit.

Credit unions offer a similar type of insurance through the National Credit Union Administration (NCUA). You can visit each of these corporations’ sites to verify that the institution you’re thinking of banking with is federally insured or that the products offered by that online institution are provided by a parent company that is federally insured. 

The takeaway 

If you’re considering switching to a new financial institution, it isn’t a bad idea to vet it before entrusting it with your funds. Take the time to verify that any institutions you’re considering are insured by a federal or national entity so that your money is protected no matter what.