Core deposits are an important but often elusive concept with implications for both interest rate risk and liquidity. A strong core deposit base can help insulate a bank from interest rate swings and market turmoil. Accurately defining and measuring core deposits remain significant challenges for regulators, bank managers, and analysts. How can recent experience help us better identify what’s a core deposit – and what isn’t?
Some of a bank’s deposits are stable across a wide range of economic environments. These “core” depositors are less sensitive to changes in market interest rates. Banks with a large share of core deposits should also be well positioned to handle liquidity stresses thanks to their army of loyal depositors. Examiners consider core deposit levels in their assessments of interest rate risk and liquidity. The FDIC even incorporates a bank’s core deposit ratio into its deposit insurance assessment. Defining core deposits is quite another matter, however.
What’s in a Name?
Definitions of core deposits historically focus on their categorization for reporting purposes rather than their behavior. The definition almost always excludes brokered deposits. It sometimes also excludes retail CDs. It nearly always includes savings accounts and other types of demand deposits.
During the 1980s and 1990s, many viewed savings accounts as a quaint legacy of another era, with stable and rate-insensitive depositors. That changed in the early 2000s when ING Direct introduced the Orange Savings Account. While technically a savings account, the OSA was internet-based and offered higher rates than were available at other banks. Most high yield savings accounts still follow a similar model. Some banks pay as much as 5.25% on savings accounts while others pay only 0.01%. It makes little sense to think of these two types of savings accounts the same way.
Section 1506 of Dodd Frank Act required FDIC to conduct a study to redefine core deposits for purposes of calculating insurance premiums. The FDIC completed the study in 2011. The study acknowledged changes to the deposit market but recommended against major legislative or regulatory changes. The FDIC focused more on restrictions on brokered deposits rather than refining the definition of core deposits. The study considered including high-rate deposits in the definition of brokered deposits but raised concerns with requiring additional reporting and notice and notice-and-comment rulemaking.
The Uniform Bank Performance Report (UBPR) defines “Core Deposits” to include all domestic deposits EXCEPT: brokered deposits and time deposits (CDs) with balances above the $250,000 deposit insurance limit. The FDIC insurance assessment uses a similar calculation, but the CD exclusion only applies to the uninsured portion (i.e., the amount above $250,000).
These definitions treat high yield savings as core deposits. More concerning is that uninsured demand deposits get core deposit treatment as well. These are the most volatile deposits on most banks’ balance sheets. At least CDs impose penalties on early withdrawals. Brokered CDs are even more restrictive, usually limiting early withdrawals to cases of death or adjudication of incompetence.
Core Deposits and Recent Bank Failures
The 2011 FDIC study looked at the relationship between brokered deposits and bank failures. We can also look at more recent bank failures and the UBPR’s definition of Core Deposits to see whether it provides a meaningful measure of liquidity risk.
The table below shows the trend in core deposits at SVB, Signature, First Republic, and Republic First. As of December 2022, each of the banks showed healthy levels of core deposits, above the Large Bank median. SVB and Signature had already failed before filing the March 2023 Call Report. First Republic saw a precipitous drop in March 2023 and failed shortly afterwards. Republic First showed a slow and steady bleed consistent with its ultimate failure. The core deposit metric was only meaningful as an after-the-fact indicator of deposit outflows.
Otherwise, the current definition is worse than useless. It can provide a false sense of security by suggesting that a bank’s deposits are more stable than they are. An experienced examiner should already focus on substance over form and understand that just because something is called a “core deposit” on the UBPR doesn’t mean it is one. The FDIC’s Risk Manual for Liquidity and Funds Management notes that “Management and examiners should not automatically view ‘core’ deposits as a stable funding source without additional analysis.” Still, that’s the presumption. The Manual does not include uninsured demand deposits among the examples of “core deposits” that are not stable funding sources.
While the core deposit ratio informs an examiner’s overall liquidity determination, the FDIC also hardwires the ratio into deposit assessment scorecards for large and for highly complex institutions. Uninsured deposits are one of the most volatile sources of funding during times of stress, with uninsured demand deposits especially volatile. Treating these deposits as a source of strength rather than a vulnerability is like ignoring the incidence of hurricanes when charging for flood insurance.
A New Approach
Regulators can take both short- and long-term steps to align core deposit reporting more closely to reality. This is especially true with uninsured deposits. Using existing Call Report line items, regulators could tweak the Core Deposit formula as follows:
Core Deposit Ratio:
Current = (Domestic Deposits – Brokered Deposits – CDs>$250K)/Total Assets
Revised = (Domestic Deposits – Uninsured Deposits – Insured Broker Deposits)/Total Assets
The revised approach is less conservative in some respects in that it treats the insured portion of large deposits as core deposits. Still, it would dramatically change the Core Deposit Ratio for the riskiest banks.[1] The table below compares Core Deposit Ratios as of December 2022 for the four failed banks under current and revised approaches.
Revising the core deposits definition in the UBPR would require a minor programming change and an edit to UBPR User Guide. A sufficiently motivated regulator with some programming skills could probably knock off the task in a few hours. Getting all the regulators to agree to the change might take ten years😊 But it shouldn’t.
Revising the FDIC assessment calculation would be similarly easy by just mimicking the revised UBPR approach. Implementing the change would not require legislation because the FDIC already has broad discretion in determining premiums. It would need to go through the usual rulemaking process. Banks with a lot of uninsured deposits won’t like it and would probably squawk.
High-Rate Deposits
Backing out high-rate deposits from the Core Deposit Ratio would require more effort, including new line items in the Call Report. Banks could start to report the balance and weighted average rate on “High-Rate Deposits.” The Call Report definition could establish thresholds for high-rate deposits based on the “National Deposit Rates Rate Cap Adjusted.” The FDIC already publishes this information monthly. Adding these line items would also provide a more forward-looking view of deposit costs and interest rate risk. The UBPR currently infers yields from interest expense, an imprecise and lagging indicator.
Unfortunately, regulators have shown little appetite to enhance IRR reporting. They do appear more willing to adjust on the liquidity side. However, changes to the Call Report typically meet considerable resistance. The 2011 study noted that a more comprehensive approach to measuring core deposits “would require that banks undertake considerably more tracking and reporting of deposits.” But is it unreasonable to expect federally insured banks to track, segment, and report key characteristics of their deposits?
Notes
By regulation, high-rate deposits become de facto brokered deposits if a bank falls from well capitalized to adequately capitalized. FDIC revised high-rate thresholds in 2021 to align more closely to Treasury yields. The previous threshold used national average deposit rates. This created huge cliff effects for banks that relied on high yield savings. The national rate cap under the old definition is 1.20%, meaning that banks with high yield savings will need to dramatically cut their rates if they fall below well capitalized.
The scorecards include “ability to withstand funding related stress.” That measure weights the Core Deposit Ratio 60% for large banks and 50% for highly complex banks.
The proposed change would have little impact on banks less reliant on large deposits. The Core Deposit Ratios for Discover and Synchrony would decline by less than four percentage points.