Small Business Series: What Happens to a Line of Credit After a Bank Failure

In today's highly interconnected financial landscape, it's important for businesses to understand what happens to their financial instruments and credit lines in the event of a bank failure like the ones that occurred at Silicon Valley Bank and Signature Bank. While rare, bank failures can have a significant impact on businesses that rely on their services for funding and financial support. In this article, we will explore what happens to a business's line of credit if their bank fails, and what steps businesses can take to prepare for this scenario.

First, it's important to understand what a line of credit is and how it works. A line of credit is a type of flexible loan that allows businesses to borrow money as needed up to a certain limit. It functions similarly to a credit card, in that the borrower only pays interest on the amount they borrow, and can access funds as needed. However, unlike a credit card, a line of credit typically has a higher credit limit and lower interest rates, making it an attractive option for businesses that need a reliable source of funding for ongoing expenses or unexpected costs.

When a business applies for a line of credit, they typically do so through a bank or other financial institution. The terms of the line of credit agreement will outline the interest rate, credit limit, repayment terms, and other conditions of the loan. The bank will also perform a credit check and assess the business's financial health to determine whether they are eligible for the line of credit.

If the bank that issued a business's line of credit were to fail, the implications for the business could be significant. One possible scenario is that the line of credit is terminated immediately, and the business is required to repay the outstanding balance immediately. This can be a major burden for businesses that rely on their line of credit to finance ongoing operations or unexpected expenses.

However, in many cases, the line of credit will not be terminated immediately. If the bank fails, the line of credit may be transferred to another financial institution that acquires the failed bank's assets and liabilities. This is a common occurrence in bank failures, as the FDIC (Federal Deposit Insurance Corporation) typically steps in to take over the bank's assets and find a buyer for them. In this scenario, the business's line of credit would continue to exist, but with a different bank or financial institution managing it.

Another possibility is that the line of credit is sold to a third-party buyer as part of the bank's liquidation process. This is less common than a transfer to another institution, but it can happen if there is a buyer willing to purchase the line of credit as part of the bank's assets. In this scenario, the business would need to negotiate new terms or repayments with the new buyer, which could include higher interest rates, more restrictive terms, or lower credit limits.

It's worth noting that the FDIC has a number of measures in place to protect businesses and individuals in the event of a bank failure. For example, the FDIC insures deposits up to $250,000 per account, per bank. This means that if a business has a line of credit and other deposits with the same bank that fails, they will be insured up to $250,000 for each account. Additionally, the FDIC has a process in place to ensure that depositors have access to their funds even if the bank fails, which can help to minimize disruption for businesses and individuals.

However, what we have seen recently is the FDIC moving to insure all deposits at Silicon Valley Bank and Signature Bank. Therefore, at least in the immediate future, business deposits in FDIC insured accounts are safe, even if they are in excess of $250,000.

If you’re concerned about the stability of your financial institution or if your business requires immediate access to a line of credit, take a look into opening a second line of credit with a different financial institution than the one with whom you are currently banking.