Best Substitute for TAG May Be Product Many Banks Wrote Off

Sweep accounts were developed in the 1970s, primarily to circumvent the ban on paying interest on business checking accounts. Some bankers believe Dodd-Frank's repeal of that ban means they are no longer relevant. In my opinion, those who hold this belief are in error.

I should disclose upfront that my bank has a division that sells software and forms for other banks to manage their sweep programs. But I'm writing as a banker who looked at various solutions to a problem most community banks now face. I found sweep accounts were the best answer for my institution, and readers are invited to share their perspectives, which may differ, in the comments section below.

The problem: As the result of hundreds of bank failures over the last several years and the recent expiration of the Transaction Account Guarantee program, large depositors are refocusing on the safety of their funds. Since TAG ended, net withdrawals at the nation's largest banks, growth in money market fund assets and noticeable declines in the overnight Treasury repo market's rates suggest some are seeking safety outside of banking. I am hearing members of my community talking about restructuring their accounts or changing banks if necessary to enhance protection. 

Those of us who want to retain this funding, or at least circle the wagons around some of our best commercial relationships, have no choice but to solve the problem of how to protect customer funds over the $250,000 FDIC insurance limit. As I see it, we still have four options. 

Bankers who aren't worried about the funding, and are confident enough to invest customer funds (and their bank's reputation) in a non-FDIC-insured product outside their control can offer a money market sweep option.  Not me.

If you can find it and afford it, private excess deposit insurance remains an option. I can't convince myself, however, that private insurance is as secure as the FDIC, nor do I want to have that conversation with my customers.

Two weeks ago, our bank hosted a presentation by a representative of Promontory regarding its Insured Cash Sweep service. Like that firm's CDARS program, ICS leverages and coordinates multiple FDIC charters. The representative reported that ICS has over 900 participants and processes about $1 billion each day through Promontory's allocation software. (Editor's note: A Promontory spokesman says ICS handles $7.5 billion a day and has more than 1,000 customers.)

With 30 years of offering sweep accounts under our belts (more on that later), we decided ICS isn't for us.  Despite being an attorney and tenured banker, I struggled with the complexity of the program, and more important, how our people would explain it to customers. Moreover, I don't know how I could convince anyone to move the daily cutoff from 2 p.m. Central time to 10 a.m.  As for the economics, despite no sign-up fee right now, ICS would add 15 basis points to cost of these funds for a bank of our size. And maybe I'm old-fashioned, but having my customers see other banks' names on their bank statements and sending them to a website other than ours is unsettling – not to mention my broader concern that a nonbank is building a system that we are paying for and that could come to have a significant influence on one of our material funding sources, large depositors.

And then there are good old sweep accounts. These were once considered a compliance challenge. But today the right legal documents and software enable bankers to easily manage fully compliant in-house sweep account programs using overnight repurchase agreements (overnight repos). Best of all, sweep repos aren't dependent on anyone else's financial performance or reputation.

With a sweep repo program, no money ever leaves the bank. The balances simply move between types of accounts: the demand deposit account and an investment account. The repo is simply a contract between a bank and its customer and constitutes a bank liability secured by government securities. After all deposits and checks affecting the DDA have been processed, the bank's core system can automatically transfer funds in excess of $250,000 to the investment account.

When sweep accounts using repos are executed properly, I know customers have the security of a perfected interest in the collateral, and the bank has a fully compliant product. FDIC regulations and resolution history since the Government Securities Act was adopted in 1986 provide bankers and their customers with the peace of mind of knowing that their money is not only safe, but remains in their local bank and transferred neither to Wall Street nor around the country through a series of transactions designed to leverage the insurance coverage afforded by other networked institutions. 

Hundreds of banks across the country continue to use sweep accounts. With dozens of customers and millions of dollars in sweep accounts, we have no plans to eliminate or replace our program. Sweep accounts are a simple and proven method for protecting and retaining high balance depositors and are by no means dead.

Joe Slavens is president and CEO of Northwest Bank and Trust Co., a $200 million-asset community bank based in Davenport, Iowa. 

Question from the editor: What's the best substitute for TAG? Leave a comment below.