Could my bank or lender go bankrupt, and what would happen to my money?

In light of recent bank closures in the United States, it’s no surprise that many Australians are worried if their small bank is next.

Firstly, let’s lay some soothing truth out there. It is highly unlikely that an Australian bank will go bust. Cases like Silicon Valley Bank (which is an investment bank) are very rare to happen in Australia since obtaining an official license to be a deposit taking institution is not an easy task. Most banks want to succeed and shutting its doors is the last thing on the to-do list.

Plus, the structure of banking and regulatory incentives put in place by the Australian Prudential Regulation Authority exists to prevent such a situation from happening.

And if such an event were to pass, up to $250,000 of your money in a bank account, savings or term deposit is protected, along with the maintenance of loans. 

Surprise, banks and lenders are capitalist enterprises! They make money in a few different ways, and understanding how they do so – and how they might go broke – is essential to this discussion. They have four main sources of income:

• Interest on loans: This is the hot money ticket for lenders, and includes the interest borrowers pay on home loans (the biggest slice of the pie), personal loans and business loans. And how do banks and other lenders offer loans? By using depositors’ money. You may be earning interest on your savings (at a cost to the bank), but lenders charge borrowers a higher interest rate, so the scales even out to a profit in the lenders’ favour.
  
• Interest on credit cards: Similarly, if you take out a credit card, you’re making interest repayments into the banks’ pockets.
  
• Product fees: These are all the account-keeping, application, discharge, late payment, ATM and other costs potentially associated with any financial product which are paid to lenders.
  
• Insurance and other financial services: Banks offer home insurance, life insurance, car insurance and travel insurance with payments upping their profits. Other services like financial planning also add to the money pot.

The possibility of these sources of income failing is dependent on an exorbitant number of customers taking certain actions. These include:

• Defaulting on loans: This is customers failing to meet loan repayments and lenders choosing to write off these loans. It isn’t something banks want to do, as loans are typically a primary asset. 
  
• Mass deposit withdrawals: Otherwise known as a ‘bank run’, this involves masses of customers panicking and rushing to withdraw their money. At a certain point a bank’s reserve of cash will run out, and they’ll have to sell their loan portfolio onto another institution and shut up shop.

To reiterate, banks and lenders closing because of this would require a mass exodus. If something like this were to happen, the Australian Government will step in with the Financial Claims Scheme (FCS). Read on for more details.

Amidst the Global Financial Crisis in 2008, the Australian Government introduced the FCS to protect deposit holders if financial institutions fail. It covers all Authorised Deposit-taking Institutions (ADIs) – that’s banks, building societies and credit unions, as well as policyholders from general insurance providers – and means customers will have their money reimbursed by up to $250,000 should the banks go under (see Mozo’s Financial Claims Scheme guide for which accounts are covered). 

If you are flying high and have more than that sum deposited with one ADI, you won’t be guaranteed anything beyond the $250k. But if you have deposits in multiple institutions collectively amounting to more, you’ll receive up to $250,000 back in each instance – read the fine print though, as numerous institutions might be registered under one ADI.

And don’t stress if your money doesn’t sit in a bricks-and-mortar bank: officially licensed neobanks and online banks must also have an ADI licence to conduct banking activities, so you’re covered.

For many, a home loan will be one of the largest financial commitments that’ll need to be addressed should the lender that is financing it fail. Happily, a bank can’t ask you to fork out and immediately pay the rest of your mortgage or kick you out of your house just because they’re struggling. If they were to close, your home loan would likely be sold onto another lender and you’d keep making your agreed-upon repayments.

Depending on which player you’re now dealing with and the rates they set, the interest rate applied to your home loan may be affected, so you may want to consider refinancing.

If you are using an offset account against your home loan to reduce interest repayments, you’re happily in the clear – offset accounts can only be offered by ADIs and are covered by the FCS. But things get complicated with redraw facilities. If you’ve been making extra repayments on the loan, safe in the knowledge that you can redraw on them in times of need, the new lender that takes on your loan will likely ‘recast’ it, essentially absorbing the amount into your loan and making those extra funds inaccessible.

While you won’t have lost any cash, it does make your mortgage less flexible, which can be problematic if you’re facing other financial hardship. Again, with banks that are unlikely to fold, this is not a highly probable outcome. But if your home loan is with a smaller lender or one that doesn’t have an ADI licence and thus doesn’t have the government guarantee, this is an important factor to consider.

Above all else, don’t panic. The best course of action is to stay informed about the economic climate, and keep up with developments related to financial support from the government and relief your bank or non-bank lender may be offering. 

Want to be financially prepared for any event? Use our budget calculator to figure out your finances and check out the current interest rates on home loans.