The Federal Deposit Insurance Corp. last week issued a regulation limiting the use of brokered deposits by some financial institutions. The regulation takes effect June 16. Excerpts follow:

This rule prohibits undercapitalized institutions from accepting funds obtained, directly or indirectly, by or through any deposit broker for deposit into one or more deposit accounts.

Adequately capitalized institutions may accept such funds only if they first obtain a waiver from the FDIC.

Well capitalized institutions may accept such funds without restriction.

The rule also limits the rates of interest that may be offered by insured depository institutions that are undercapitalized or adequately capitalized.

The FDIC Improvement Act (1991) requires the FDIC to adopt these regulations.

This final rule defines and clarifies key terms used in the statute. It describes the application process whereby adequately capitalized insured depository institutions may obtain a waiver from the FDIC authorizing the acceptance of funds obtained by or through a deposit broker.

Provisions of Old Law

Before the new statute was adopted, the Federal Deposit Insurance Act had prohibited "troubled" institutions from accepting funds obtained, directly or indirectly, by or through any deposit broker for deposit into one or more deposit accounts.

A troubled institution was defined by statute to mean any insured depository institution that did not meet minimum capital requirements applicable with respect to such institution (that is, an "undercapitalized" institution). Renewals and rollovers of any amount on deposit in any such account were treated as an "acceptance" of funds under the statute.

The term "deposit broker" was broadly defined to mean:

* "Any person engaged in the business of placing deposits, or facilitating the placement of deposits, of third parties with insured depository institutions or the business of placing deposits with insured depository institutions for the purpose of selling interests in those deposits to third parties."

* "An agent or trustee who establishes a deposit account to facilitate a business arrangement with an insured depository institution to use the proceeds of the account to fund a prearranged loan."

Several exceptions to this definition were set out in the statute. Most of the exceptions concerned depositors acting in certain, specifically described, fiduciary relationships (for example, the trust department of an insured depository institution, the trustee of a pension plan or other employee benefit plan, the trustee of a testamentary account, the trustee of an irrevocable trust, etc.).

Seized Institutions

The FDIC was authorized to waive the prohibition on the acceptance of brokered deposits on a case-by-case basis upon a finding that the acceptance of such deposits did not constitute an unsafe or unsound practice with respect to the institution applying for a waiver. The FDIC was also authorized to exempt certain insured depository institutions for which the FDIC had been appointed conservator.

The Federal Deposit Insurance Act also regulated the interest rates that troubled institutions could offer. The restrictions on interest rates were achieved through definitions employed in the statute.

More specifically, the term "deposit broker" was defined to include "any insured depository institution, and any employee of any insured depository institution, which engages, directly or indirectly, in the solicitation of deposits by offering rates of interest (with respect to such deposits) which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions having the same type of charter in such depository institution's normal market area."

Judging by the Advertising

The phrase "normal market area" was not defined by statute, but generally it was constructed by the FDIC to mean the area in which an institution was advertising a particular type of deposit.

As a result of this definitional provision, an insured depository institution and its employee(s), were deemed to be deposit brokers if they solicited deposits by offering interest rates that were significantly higher than the prevailing rates offered in the institution's normal market area.

Since troubled institutions were not permitted to accept deposits obtained through any deposit broker, absent a waiver from the FDIC, troubled institutions could not solicit deposits by offering rates that were significantly higher than the prevailing rates unless they first obtained a waiver.

This provision was intended to prohibit the solicitation of deposits by in house, salaried employees through so-called money-desk operations.

It addressed a concern that brokered deposit restrictions could be easily circumvented by in-house solicitation or general newspaper advertising of high rates.

New Law Expands Curbs

The newly enacted FDIC Improvement Act significantly expands the current limitations on brokered deposits. Under the statutory scheme it created, "well capitalized" insured depository institutions may accept, renew, or roll over brokered deposits without an FDIC waiver.

However, "adequately capitalized" insured depository institutions are prohibited by the new law from accepting, renewing, or rolling over brokered deposits unless they first obtain a waiver from the FDIC.

"Undercapitalized" insured depository institutions are prohibited from accepting, renewing, or rolling over brokered deposits. On June 16, the FDIC will lose its authority to grant undercapitalized institutions a waiver authorizing the acceptance of brokered deposits.

(There is, however, a limited exception for insured depository institutions of which the FDIC has been appointed conservator.)

Undercapitalized institutions that are currently accepting brokered deposits pursuant to a waiver issued by the FDIC will be prohibited from accepting further deposits on June 16.

The new law expands the interest rate restrictions set out in the existing statute. It increases the number of institutions subject to the interest rate restrictions due to the fact that the new prohibitions now apply to adequate capitalized institutions as well as to undercapitalized institutions. In addition, the new law eliminates the FDIC's authority to exempt an institution (whether adequately capitalized or undercapitalized) from the interest rate restrictions through a waiver.

Undercapitalized institutions are prohibited under the new law from soliciting deposits by offering rates of interests that are significantly higher than the prevailing rates of interest on insured deposits in their normal market areas or in the market area in which such deposits would otherwise be accepted.

Rate Benchmarks

Adequately capitalized institutions that accept brokered deposits pursuant to a waiver from the FDIC are prohibited from paying a rate of interest on such funds which, at the time that such funds are accepted, renewed, or rolled over, significantly exceeds:

* The rate paid on deposits of similar maturity in such institution's normal market area for deposits accepted in the institution's normal market area.

* The "national rate" paid on deposits of comparable maturity for deposits accepted outside the institution's normal market area.

The national rate is to be established by the FDIC. The new law does not impose interest rate restrictions on well capitalized institutions.

The new law retains the definition of "depositor broker" set out in the current law.

Consequently, the term "deposit broker" continues to include any insured depository institution, and any employee of any insured depository institution, which, directly or indirectly, solicits deposits by offering rates of interest that are significantly higher than the prevailing rates of interest offered by other insured depository institutions having the same type of charter in the offering depository institution's normal market area.

The apparent effect of this provision is to limit the rate of interest an adequately capitalized institution may offer on this type of deposit, as well as those obtained through a third-party intermediary.

The FDIC recognizes the circularity of the law that says solicitation of deposits by offering significantly above-market rates of interest makes those deposits brokered funds, and an adequately capitalized institution, even with a FDIC waiver, cannot pay a rate of interest on brokered funds that significantly exceeds market rates.

This however, seems to be the clear result of the statutory language, and the consequence is that a merely adequately capitalized institution can never solicit deposits by offering rates of interest significantly higher than the relevant local or national rates.

Initial Proposal And Revisions

On March 24, the FDIC adopted a proposed rule designed to implement the new statutory scheme for regulating brokered deposits.

For the most part, the proposed rule tracked the language of the statute. The proposed rule did, however, offer definitions for the terms "well capitalized," "adequately capitalized," and "undercapitalized."

In order to fully effectuate the interest rate restrictions imposed by the new law, the proposed rule outlined a method of calculating the "national rate" created by the new law.

In addition, it clarified the meaning of "significantly higher" as it relates to the interest rate restrictions. The proposed rule described a waiver application process. The specific provisions of the proposed rule are described in more detail below.

Increasingly Strict

The new law tracks the language of other provisions in the 1991 law calling for progressively more stringent restrictions and supervision as capital levels decline.

Thus, well capitalized institutions may accept brokered deposits without restriction.

Adequately capitalized institutions may accept brokered deposits they first obtain a waiver from the FDIC.

Undercapitalized institutions may not accept brokered deposits.

The terms "well capitalized" and "adequately capitalized" are not defined in the new law.

However, those terms are the same as found in section 38 of the Federal Deposit Insurance Act (the old law) dealing with prompt corrective action. Further, the new law indicates that the term "undercapitalized" is to have the same meaning as provided in section 38.

The precise regulatory definitions of the different capital levels identified in section 38 are being developed in consultation with the other federal banking agencies. They will not be available until some time beyond the date when final regulations implementing the new brokered deposit restrictions must be in place.

For consistency and in keeping with the evident intent of Congress, the FDIC intends to adopt the section 38 definitions of capital levels when they become effective.

In the interim, the proposed regulation defined "well capitalized" to mean an institution whose leverage and risk-weighted capital ratios are at least one to two percentage points higher than otherwise currently required by applicable regulations.

The FDIC stated in the proposed rule that it intended to adopt a precise percentage point and possibly other elements but desired to receive the comments of interested persons before selecting the appropriate measure.

Capital-Level Definitions

In addition, the proposed rule provided that a "well capitalized" institution must be Camel Or Macro-rated 1 or 2 and may not be under any outstanding order or written direction to achieve a specific higher level of capital.

An "adequately capitalized" institution was defined as one that fails to meet the standard for "well capitalized" but is not "undercapitalized."

An "undercapitalized" institution was defined as one that fails to meet any regulatory minimums after giving effect to any chargeoffs or other capital reductions directed by a federal or state regulator. This would have included any institution which had been directed to achieve a specific higher level of capital and had not yet met that higher capital level.

An exception was created for any institution that met the minimum regulatory capital requirements but had been directed or advised to achieve a specific higher level of capital. Such an institution would have been considered adequately capitalized if:

* It had committed to and was in compliance with a plan designed to achieve the specific higher level of capital directed or otherwise required.

* The plan had been accepted in writing by the regulator requiring the specific higher level of capital.

The definition of "well capitalized" has been changed in the final rule so as to exclude any institution that is in a "troubled condition".

For purposes of this final rule, the term "troubled condition" is defined by reference to regulations issued pursuant to section 32 of the old law.

Granting of Waivers

The definition of "undercapitalized" has also been changed in the final rule; that status is determined solely by failing to meet the regulatory minimums.

An adequately capitalized institutions is in between, and if in a "troubled condition," the FDIC will consider its performance and commitment to a corrective program in deciding whether to grant a brokered deposit waiver.

The criteria as originally proposed and summarized above are likely to be part of any waiver conditions (that is, compliance with a capital restoration plan accepted in writing by the applicable regulator).

The [FDIC] board intends to lower or eliminate the leverage capital component from the definitions of "well capitalized," "adequately capitalized," and "undercapitalized," after the risk-based capital standards have been revised by each federal banking agency to take into account interest rate risk as required by the new law and after experience has been gained with such standards.

Interest Rate Limitations

Although an adequately capitalized institution may accept brokered deposits with a waiver from the FDIC, it may not pay a rate of interest on such deposits which, at the time that such deposits are accepted, significantly exceeds:

* The rate paid on deposits of similar maturity in such institution's normal market area for deposits accepted in its normal market area.

* The "national rate" paid on deposits of comparable maturity for deposits accepted outside the institution's normal market area.

The FDIC examined several alternatives for purposes of establishing the "national rate."

First, it considered periodically surveying markets throughout the country and compiling and publishing rates for deposits of various maturities.

The second alternative examined was reference to publications that currently publish deposit rates.

A third possible approach was to tie the national rate to comparable Treasury securities, with some additional margin.

The alternative selected for inclusion in the proposed rule was based on Treasury securities.

The proposed rule provided that the national rate would be determined by reference to the current yield of similar-maturity U.S. Treasury obligations published daily, plus 100 basis points, or 150 basis points in the case of any deposit at least half of which is uninsured (wholesale deposits).

The final rule continues to provided that the national rate will be computed by reference to comparable Treasury securities. However, the method of calculating the national rate has been simplified.

Ordinarily, the national rate will be 120% of the current yield on similar-maturity Treasury securities; in the case of institutional (wholesale) deposits, the national rate will be 130% of the current yield on similar-maturity Treasury securities.

The FDIC requests comment from any party that is unreasonably constrained by these limits and will consider whether any future amendment to the regulations is appropriate.

As outlined above, the new law prohibits undercapitalized and adequately capitalized institutions from soliciting funds by offering interest rates that "significantly exceed" the prevailing rate or that are "significantly higher" than the prevailing rate.

Based upon its reading of the statute and a review of the legislative history, it is the FDIC's view that Congress did not intend to suggest that the phrases "significantly higher" and "significantly exceed" are to have different meanings. Consequently, the FDIC construes the two phrases as having the same meaning.

For purposes of implementing the interest rate limitations imposed by the new law, the proposed rule defined the phrases "significantly exceeds" or "significantly higher" to mean 50 basis points. In other words, an interest rate would be "significantly" excessive or "significantly" higher than a prevailing market rate if it exceeds that rate by more than 50 basis points.

In response to the comment letters received, this number has been changed in the final rule from 50 basis points to 75 basis points.

The proposed rule offered a new definition for the phrase "market area."

Previously, FDIC regulations described an institution's "normal market area" as the area in which an institution is advertising and soliciting a particular type of deposit. The normal market area could vary from office to office or for different types of deposits.

The media used to advertise and solicit a particular type of deposit and the normal coverage of those media were important considerations in defining the market for that deposit.

The old FDIC regulation stated that, in "each case, the rates offered for the particular deposit must be compared with the rates offered by the other institutions with the same type of charter, without regard to size, in the particular geographic market in which that deposit is being solicited, whether the market is national, regional, or local in character."

Under the proposed new rule, the term "market area" was more broadly defined to mean "any readily defined geographical area in which rates offered by any one insured depository institution operating in the area may affect the rates offered by other institutions operating in that same area."

Case-by-Case Decisions

That definition has been adopted in the final rule. It is designed to facilities a case-by-case determination of market area based on the economic impact of a particular institution's efforts to solicit deposits in an area.

The proposed rule noted that, when comparing rates offered or paid to market rates, there has been some confusion in the past as to what was intended since both the statute and current regulation simply referred to "rates" without elaboration.

The FDIC attempted to clarify this requirement by explicitly referring to "nominal" rates of interest in the proposed rule. Staff was of the view that results ordinarily would not change significantly whether nominal rates were compared to nominal rates or yields to yields. Consequently, nominal rates were proposed for simplicity of administration and enforcement.

Application for a Waiver

The proposed rule provided that adequately capitalized institutions wishing to obtain a waiver must file an application in letter form with the appropriate FDIC regional director.

The proposed rule outlined the information required to be submitted in the waiver.

It was also provided that any application filed by an institution that is Camelor Macro-rated 1 or 2 by its primary federal regulator would be deemed approved for the period requested (not to exceed two years) 30 days after the application was filed with the FDIC, unless the institution is notified in writing during the 30 days that the FDIC requires additional time to review the application.

These proposals have been adopted in the final rule, largely without change, except that the 30-day waiting period has been reduced to 21 days.

Key Provisions Summarized

A "well capitalized institution" is one that has:

* A ratio of total capital to risk-weighted assets of not less than 10%.

* A ratio of Tier 1 capital to risk-weighted assets of not less than 6%.

* A ratio of Tier 1 capital to total book assets of not less than 5%.

* Not been notified by its appropriate federal banking agency that it is in a "troubled condition."

An "undercapitalize institution" is one that fails to meet the minimum regulatory capital requirements prescribed by its appropriate federal banking agency.

An "adequately capitalized institution" is one that is neither well capitalized nor undercapitalized.

The statute regulates the acceptance by insured depository institutions of funds obtained, directly or indirectly, by or through any deposit broker for deposit into one or more deposit accounts (that is, "brokered deposits").

Well capitalized insured depository institutions may accept brokered deposits without restriction.

Adequately capitalized insured depository institutions are prohibited from accepting brokered deposits unless they first obtain a waiver from the FDIC.

Undercapitalized institutions are prohibited from accepting brokered deposits.

Adequately capitalized institutions desiring to obtain a waiver from the FDIC must file an application in letter form with the appropriate FDIC regional director.

The final rule provides for a 60-day transitional period.

An adequately capitalized institution that files an application with the FDIC within 30 days of the effective date of the final rule may accept, renew, or roll over brokered deposits for a period of 60 days following the effective date of the final rule, unless otherwise notified by the FDIC.

Interest Rate Restrictions

Undercapitalized institutions may not solicit deposits by offering rates of interest that are significantly higher than the prevailing rates of interest on insured deposits:

* In such market institution's normal market areas.

* In the market area in which such deposits would otherwise be accepted.

Adequately capitalized institutions that accept brokered deposits pursuant to a waiver from the FDIC are prohibited from paying a rate of interest on such funds which, at the time that such funds are accepted, significantly exceeds:

* The rate paid on deposits of similar maturity in such institution's normal market area for deposits accepted in the institution's normal market area.

* The national rate paid on deposits of comparable maturity for deposits accepted outside the institution's normal market area.

The national rate is 120% of the current yield on similar-maturity U.S. Treasury obligations or, in the case of any deposit at least half of which is uninsured (institutional or wholesale deposits), 130% of such applicable yield.

|Deposit Broker'

A rate is deemed to be "significantly" higher or excessive if it exceeds by more than 75 basis points the applicable benchmark (that is, the local rate or national rate).

Under the statute, the term "deposit broker" includes any insured depository institution, and any employee of any insured depository institution, that solicits deposits by offering rates of interest which are significantly higher than the prevailing rates of interest offered by other insured depository institutions having the same type of charter in the offering depository institution's normal market area.

The apparent effect of that provision is to limit the rate of interest an adequately capitalized institution may offer on this type of deposit, as well as those obtained through a third-party intermediary.

A merely adequately capitalized institution cannot solicit deposits by offering rates of interest that are significantly more than the relevant local or national rate.

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