The observation that correlation does not equal causation has been put in the service of some sketchy claims in the past. It was a longtime favorite of the tobacco industry, which argued for decades that lots of smokers dying of lung cancer did not prove smoking causes cancer.
It also applies to an issue the Federal Deposit Insurance Corp. has been grappling with over the past two years. In the continuing banking crisis, the FDIC has autopsied a lot of dead banks, and rather than find that they were hooked on Marlboros, in many cases they have diagnosed an addiction to brokered deposits.
But have brokered deposits caused bank failures? Or do banks already on the road to ruin just tend to pick up lots of brokered deposits along the way?
In different times, the FDIC might have tried to answer those questions through methodical study of trends and bank financial reports. But with banks failing at the rate of nearly three per week in 2009, time was scarce to distinguish if it was just coincidence.
In early 2009, the agency increased assessments on any bank with more than 10 percent of its deposits in brokered funds. A separate rule, taking effect Jan. 1, imposed interest-rate caps on banks that fell below the well-capitalized standard and closed loopholes that had let some of those banks continue using this high-cost funding.
As the agency cracks down on brokered deposits, banks are getting the message. Some are steering clear of such funding entirely and looking for alternatives.
Tommy Ellison, the chairman and chief executive officer of Commercial Bank of Texas in Nacogdoches, says his bank has used brokered deposits but currently holds none. "We don't view it as cost-effective," he says. "If you really understand what you are paying for deposits and whether that deposit customer is profitable for your bank, the real question you have to ask is, does it make money for you?"
He adds that to justify the higher cost of funding with brokered deposits, a bank must take on higher-risk credits, which requires underwriting capabilities that few community banks possess.
Some state banking associations have begun programs designed to help institutions boost deposits without resorting to brokered funds. The Texas Bankers Association's Liquidity Assistance Program pairs banks in need of deposits with banks that have excess liquidity and leaves it to the banks themselves to work out an arrangement. Banks interested in placing excess funds on deposit with another institution fill out a form and are added to a list maintained by the association. When a bank finds itself in a liquidity crisis, it can make a confidential request for a copy of the list. The program is modeled after a similar service provided by the Louisiana Bankers Association.
Texas banking regulators "looked at this, thought it was something that was a good member service, and quite honestly it avoids brokered deposits. They don't want brokered deposits in an institution," says Eric Sandberg, the president and CEO of the Texas Bankers Association.
An agreement between banks assures that the deposits generated by the program are more like core deposits, Sandberg says. "We're not talking about hot money here."
Even some deposit brokers are unwilling to hype their product as a cure for liquidity problems. "A brokered deposit is a tool," says Christopher Mose, the head of strategy and product management in Bank of New York Mellon's capital markets division. "If that's your only source of funding, you have to re-look at your business."
Bank of New York Mellon late last summer started a brokered certificate of deposit program that by January had placed more than $200 million of deposits. The rapid growth, according to Mose, had less to do with the demand for brokered deposits - flat during the past two quarters - than with what he described as the program's stringent screening of its bank partners. The program looks for partner banks that plan to use brokered deposits in ways that do not suggest underlying problems in the institution. Mose says responsible uses of brokered deposits include funding a temporary spike in loan demand and trying to reduce reliance on other sources of wholesale funding.
The FDIC's definition of brokered deposits also has raised some concerns in the industry.
"In some respects the cure is worse than the disease because there seems to be a reliance on labels and a concern about any bank that has a significant concentration coming from what is called a 'brokered deposit,'" says Mark Tenhundfeld, a senior vice president in the American Bankers Association's office of regulatory policy. His concern focused on products such as Promontory Capital Partners' Certificate of Deposit Account Registry Service.
CDARS lets banks retain the deposits of customers who are concerned that their total balances exceed the protection offered by federal deposit insurance. It does this by brokering deals between banks for "reciprocal deposits," essentially creating multiple insured accounts at separate institutions for the customer whose total deposits exceed the insurance cap. The customer's bank gets an equal amount in deposits from other banks in the same situation to even out the deposit swap.
The FDIC treats CDARS deposits as brokered deposits. However, efforts are reportedly under way to convince the agency to exempt such products, on the argument expressed by Tenhundfeld - that they really represent core deposits.
Whatever happens, Tenhundfeld says, "In the short term it will be more difficult for banks to have anything approaching a concentration in brokered deposits - especially if they are using it to fund rapid growth. That has proved to be a toxic brew."