Early Warning Signs of Bank Failure
Bank failures don't happen without warning. In virtually every case, the deterioration is visible in publicly available data months or years before the actual failure. The challenge is not finding the signals but taking them seriously when the bank's stock price and earnings still look healthy.
Quantitative Warning Signs
Rapid asset growth is the single most reliable predictor of future problems. Banks that grow loans 15% to 20% or more annually for several consecutive years are almost certainly loosening underwriting standards, entering unfamiliar markets, or both. Growth at that pace requires either finding borrowers that competitors passed on (which should concern you) or competing so aggressively on price and terms that margins don't compensate for risk.
Declining capital ratios during a period of growth mean the bank is leveraging up. If total assets are growing faster than equity, the bank is taking on more risk per dollar of capital. This is particularly concerning when combined with rapid loan growth.
Rising classified and criticized assets, even if non-performing loans haven't spiked yet, indicate credit quality is migrating in the wrong direction. Banks report classified asset totals in their call reports. A steady increase over several quarters means the loan portfolio is deteriorating, even if charge-offs remain low.
Funding shifts from core deposits to brokered deposits, wholesale borrowings, or Federal Home Loan Bank advances suggest the bank can't fund its growth organically. Replacing stable, low-cost funding with expensive, volatile sources is a classic late-cycle red flag.
Qualitative Warning Signs
Management turnover, particularly in credit administration, risk management, or the CFO role, can signal internal disagreements about risk-taking. When the chief credit officer leaves during a period of aggressive growth, it may mean someone pushed back and lost.
Regulatory actions provide direct signals. Consent orders, cease-and-desist orders, and memoranda of understanding are public documents. They mean the regulator has identified problems serious enough to require formal corrective action. Banks under enforcement orders face constraints on growth, dividends, and acquisitions.
Earnings quality that relies increasingly on non-recurring items, reserve releases, or securities gains rather than core operating income suggests the underlying business is weaker than reported earnings indicate.
Putting the Signals Together
No single metric condemns a bank. The danger is in combinations. A bank with rapid growth, rising CRE concentration, increasing reliance on non-core funding, and a management team dismissing risk concerns on earnings calls is exhibiting a pattern that has preceded failures in every major banking crisis.
The BankSift screener can help identify banks with concerning metric combinations. Filter for high asset growth, above-peer loan concentrations, thin capital ratios, and deteriorating asset quality to build a watchlist. Then monitor those banks quarterly for further deterioration.
Related Articles
- The Savings & Loan Crisis — The S&L crisis exhibited nearly every warning sign in the playbook
- The 2008 Financial Crisis — Pre-2008 warning signs were visible years before the crisis peaked
- The 2023 Regional Bank Turmoil — SVB's warning signs included rapid growth, deposit concentration, and massive rate exposure
Related Metrics
- Texas Ratio — A Texas Ratio approaching or exceeding 100% has historically predicted bank failures
- Non-Performing Loans (NPL) Ratio — Steadily rising NPLs signal credit deterioration before charge-offs are recognized
- Non-Performing Assets (NPA) Ratio — NPAs capture the full picture including foreclosed assets
- Reserve Coverage Ratio — Falling reserve coverage as NPLs rise indicates the bank is underprovisioning
- Equity to Assets Ratio — Declining equity ratios during growth mean leverage is increasing
- Net Charge-Off Ratio — Accelerating charge-offs confirm that earlier NPL increases are becoming permanent losses