An explainer: What happens when banks fail?

What would happen to depositors if a large bank or thrift failed or had to be bailed out?

Deposits insured by the Federal Deposit Insurance Corp. would be fully covered, and there's no need to worry. But depositors should make sure now, while their bank is open, that their accounts are fully insured. There is no reason for consumers to hold uninsured deposits at any bank or thrift regardless of its health. Period.

Bank customers should make sure their accounts are fully insured by using the online estimator at www.fdic.gov/edie.

After IndyMac Bank failed and was taken over by the FDIC this year, I heard from some very panicked people who thought they might have large uninsured deposits at the thrift. Some had trust or "payable on death" accounts, which allow depositors to get additional insurance beyond the standard $100,000 limit (on nonretirement accounts) by naming certain relatives as qualified beneficiaries.

One IndyMac depositor thought his spouse had not been added as a beneficiary to the account as intended. Another realized she had named cousins as beneficiaries, not realizing they were not qualified.

FDIC spokesman David Barr could not comment on the cases, but he says depositors should make sure their trust accounts are titled correctly, with qualified beneficiaries.

Qualified beneficiaries include the account owner's spouse, child, grandchild, parent or sibling. Adopted and stepchildren, grandchildren, parents and siblings also qualify. In-laws, grandparents, great-grandchildren, cousins, nieces and nephews, friends and organizations including charitable trusts do not qualify, the FDIC says.

The account title, usually found on the signature card, certificate of deposit or bank statement, should include a term such as payable on death, in trust for, trust, living trust, family trust, or acronyms such as POD or ITF. For example, it might say John Doe ITF Jane Doe.

Uninsured deposits

What happens to uninsured deposits? That depends on what happens to the failed bank:

-- If the FDIC takes it over, as it did with IndyMac, uninsured depositors become creditors of the failed bank. As its assets are sold, they might get some or all of their uninsured money back.

The FDIC initially estimated that IndyMac had almost $1 billion in uninsured funds, but has whittled that down to $540 million.

-- If another bank takes over the failed one and acquires its deposits, all accounts -- including uninsured deposits -- move to the new bank, where they remain insured up to the FDIC limits. Depositors can leave their money with the new bank or withdraw it.

-- If another bank takes over the failed one but acquires only the insured deposits, people with uninsured deposits become creditors of the failed bank and could lose money.

About half of the banks that acquired failed ones this year took over all of their deposits; the other half did not, Barr says.

-- If a bank is deemed too big to fail, the federal government could step in and provide loans or other types of assistance to keep it going.

What's too big?

Before December 1991, uninsured depositors were paid in full when this happened. But in December 1991, Congress changed the rules for declaring banks too big to fail and since then, none has been declared too big.

If it happened today, Barr could not say what would happen to uninsured deposits.

(E-mail Kathleen Pender at kpender(at)sfchronicle.com)

(Distributed by Scripps Howard News Service, www.scrippsnews.com.)