The FDIC stirred up a hornet’s nest with proposed changes to its brokered deposits regulation. The proposal would reverse some changes made back in 2021 that narrowed the scope of deposits subject to brokered deposit restrictions. Some have criticized the proposed changes as lacking a strong empirical basis. However, the same can be said of the 2021 revisions. Let’s take a closer look at the history of the regulation, its scope, and the relevant data.
The statutory basis for brokered deposit restrictions dates to the 1989 FIRREA legislation. A federal court had blocked earlier efforts by regulators to rein in brokered deposits. FIRREA placed limits on brokered deposits for banks and thrifts in “troubled condition.” This was later modified to conform to Prompt Corrective Action capital categories. Adequately capitalized institutions required a waiver from the FDIC to take in or roll over brokered deposits. The FDIC waiver is unavailable for undercapitalized banks. The statute is otherwise little changed for the 1989 version. FIRREA “explicitly authorized” the FDIC “to impose by regulation or rule additional restrictions on the acceptance of brokered deposits by troubled institutions.” (Conference Report at ¶4218.)
Brokered deposits present several potential risks. They allow for growth beyond what is available in the bank’s local market. Rapid growth often preceded the biggest and most spectacular bank failures. In addition, since brokered deposits tend to be relatively expensive and provide little franchise value, they could dissipate the value of a troubled bank, leading to higher resolution costs to the FDIC. This problem became especially acute during the 1980s as a lack of resolution funding kept zombie banks open. The last thing regulators wanted was to prop up undercapitalized banks, or worse yet, have them try to grow out of their problems. The FDIC has also found that higher concentrations of brokered deposits are associated with both a higher probability a bank would fail and a higher cost to the FDIC.
Liquidity risk comes into play primarily due to capital-based restrictions on brokered deposits. An adequately capitalized bank can continue to offer brokered deposits only with an FDIC waiver. That waiver is not available at all if you become undercapitalized. If these deposits represent a large share of a bank’s funding, you can have a liquidity crisis on your hands. Fortunately, more than 99% of banks are well capitalized. As shown in the table below, even a bank with capital ratios below 99% of the industry would sit comfortably above well capitalized thresholds.
Brokered deposits also figure into FDIC assessments and get harsher treatment under the liquidity coverage ratio (LCR). However, LCR requirements usually don’t kick in until a bank’s total assets reach $250 billion.
There is also a supposed stigma associated with core deposits. FDIC Vice-Chairman Travis Hill expressed concern over “a reflexive judgment by examiners that the deposit is ‘risky.’” Hill acknowledged that this judgment varies depending on examiner and agency. There just isn’t much evidence that examiners reflexively treat brokered deposits as risky. More than a quarter of all banks have at least some brokered deposits, which is hard to square with the idea that examiners oppose brokered deposits per se. From my own experience, the issue is more one of concentrations. I’ve criticized concentrations of brokered deposits, just as I’ve criticized concentrations of FHLB advances or uninsured deposits. An examiner would need to ignore decades of experience to view funding concentrations as entirely benign.
In 2021, the FDIC issued a Final Rule that made significant adjustments to its brokered deposit regime. The changes fell into two broad categories. The first adjusted the rule to revise some outdated, counterproductive features. The regulation included a rate cap based on prevailing local market rates, which did not reflect the bifurcation of the deposit market. Under the old rules, the rate cap on savings accounts would be 1.21% even though some large banks offer savings rates above 5.00%. Moreover, FDIC deems a bank’s deposits as brokered if it becomes less than well capitalized and pays above the rate cap, even if the deposit did not otherwise meet the brokered deposit definition. This could create an enormous liquidity cliff as soon as a bank falls below well capitalized. The 2021 rule tied the rate cap to Treasury yields, so the current rate cap is now a more realistic 6.08%.
The FDIC also adjusted the treatment of brokered nonmaturity deposits like savings accounts. The impact of restrictions on brokered CDs is gradual. Undercapitalized banks can keep the brokered deposits on the books but can’t roll them over. Spreading maturities over months and years mitigates the liquidity shock. Since savings accounts are payable on demand, an undercapitalized bank would have needed to close those accounts immediately. Under the 2021 regulation, undercapitalized banks could maintain the brokered accounts but could not open new accounts or increase existing accounts.
The second category of revisions narrowed the definition of brokered deposits and expanded the list of exceptions. These changes had a distinct “while we’re at it” flavor. There did not appear to be a compelling rationale for making the changes. It seemed more a case that the regulators thought fintechs are cool or, in regulatory parlance, promote responsible innovation. The 2021 Final Rule notes that “the amount of deposits currently reported as brokered that may be re-designated as non-brokered as a result of the rule may be material.” The FDIC conceded, however, that “a reliable estimate of this change in designation is not possible with the information currently available to the FDIC.” Shoot first, ask questions later.
Deposits designated as “brokered” initially decreased when the rule changes went into effect but have since increased to well above 2020 levels. (See table below.) We do not know what brokered deposit concentrations would have been under the old definitions. That’s at least in terms of publicly available data. Examiners have access to a lot of nonpublic data, but data collection is rarely systematic or consistent. They instead rely on an individual bank’s MIS.
The latest FDIC proposal would leave intact the revised treatment of nonmaturity deposits and the interest rate cap calculation. The proposal would, however, scale back on the available exceptions to the brokered deposit definition. The FDIC cites First Republic, Synapse, and Voyager, which critics view as irrelevant to the proposed rule. After all, brokered deposits were not the primary cause of First Republic’s failure. Synapse was already classified as a deposit broker. The new rules would not have prevented Voyager from misrepresenting its insured deposit status. However, these cases do puncture some assumptions underlying the 2021 revisions. Affiliated sweeps are supposedly sticky, but First Republic experienced an 86% outflow of uninsured sweeps and a 26% outflow of insured sweeps over a three-month period. While the 2021 revisions were touted as providing “consumers more choices and control over their financial decisions,” those with frozen accounts might not feel that way.
The FDIC has cited an increase in underreporting and misreporting of brokered deposits as a motivation for the rule change. Misreporting makes it harder for regulators to monitor the activity and it can make correction of errors more consequential. Examiners are likely to scrutinize brokered deposit status more closely if a bank falls below well capitalized. That’s not the best time to discover errors. It could leave the bank and the regulators in an unenviable choice between allowing continued misreporting or sparking a liquidity crisis.
Some of the criticism reflects more fundamental concerns with the regulation of brokered deposits. Travis Hill has described the current brokered deposits framework as “not fit for purpose.” He suggested an asset growth limit for undercapitalized banks as an alternative. Others indicate that regulators could address concerns with some brokered deposits through guidance on third party relationships or concentrations. However, guidance is not the same as a regulation, something made quite clear back in 2021. And replacing current rules on brokered deposits with limits on asset growth would require new legislation. Since we’ve had exactly zero new banking legislation passed since the Silicon Valley failure, the odds of that happening are not high.