FDIC poised to revamp deposit rules. Banks say it's about time

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WASHINGTON — Community bankers are hopeful that the Federal Deposit Insurance Corp. will soon deliver long-awaited reforms of how it defines high-rate deposits.

The FDIC plans to solicit comment on revamping how it determines that a deposit is brokered. The change could have huge implications for less-than-"well-capitalized" banks that face restrictions on accepting new brokered deposits, among other things.

But bankers are also eager for the agency to change its methodology for setting interest rate caps for certain banks on all of their deposits. Those caps, which also apply to banks that are less than well-capitalized, are meant to prevent banks from avoiding the brokered-funds restrictions by offering above-market yields.

“The fear of God has been put into the smaller banks by their regulators, so the community banks just swear off brokered money,” said Dirk Meminger, president and CEO of Sauk Valley Bank in Sterling, Ill. “We very much appreciate the door is open to discuss the rate cap.”

While the FDIC's current methodology for setting interest rate caps was developed about a decade ago, executives and industry representatives note that its core rule defining brokered deposits was written in the nineties, before online banking existed. They argue that the rule currently captures some deposits that are not necessarily risky or come from an outside broker.

“More banks are gathering deposits through the internet that might be through a division or part of a bank, but the way the rules are written, it makes it brokered,” said Wayne Abernathy, executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association. “We think that’s shortsighted. ... Banks have always been a part of the future and this rule is one of the things that’s in the way.”

Meanwhile, others say the FDIC's methodology in setting the interest rate cap is largely based on rates offered by the biggest banks, which tend to be lower than what community banks can offer.

On Sept. 13, the FDIC signaled its interest to weigh changes to its brokered-deposits policies. The agency released a proposal implementing the Senate's regulatory relief package to exempt certain "reciprocal" deposits from being considered brokered. But the press release announcing the proposal included comments from FDIC Chairman Jelena McWilliams, which indicated plans to go even further.

Even though the interest rate cap only applies to some institutions, bankers say the regulators are pointing to the rate limits during exams for all banks, regardless of their capital level.

“It kills the community banks because the regulators come in now saying, ‘This doesn’t apply to you because you’re well-capitalized, but if it did, we would deem all these deposits volatile because you paid above the national rate cap,' " said Joe Kiley, president, CEO and director of First Financial Northwest Inc. in Renton, Wash.

Part of the industry's concern, which the FDIC is exploring, is how the agency calculates the average national interest rate that ultimately determines the cap. Under the calculation devised in 2009, the deposit rate for banks less than well-capitalized cannot exceed 75 basis points above the national average.

But Treasury yields have become significantly higher than the average national interest rates on a deposit, making certificates of deposits less appealing to consumers. For example, a one-year CD had a national average rate of 0.47% and a cap at 1.22% as of Oct. 9, according to the FDIC. During that same day, the one-year Treasury yield was 2.65%.

A consumer can “get roughly 100 basis points more and the full faith in the government” with Treasuries, “so it’s out of whack,” Kiley said. “We have a national rate cap that is artificially low.”

Critics also say the average national interest rate is largely based on what the largest banks with the most branches pay, but that is lower than what community banks offer in order to stay competitive in their local markets. Currently, community banks can request that the FDIC instead use their local market rate as a benchmark for setting the cap.

But even the well-capitalized banks have raised concerns with how the national average is applied. During a meeting at the FDIC last week of the agency's community bank advisory committee, an FDIC official acknowledged these concerns but disagreed that there is something wrong with the current calculation.

“I think it's a mathematically accurate calculation. Now, whether it's the only one or the most appropriate one, it remains to be seen,” Rae-Ann Miller, associate director for the FDIC’s division of risk management supervision, said during the meeting. It is “something certainly that we're looking at and would be interested in with our rulemaking further later this year.”

A main reason the FDIC set interest rate restrictions is that some struggling banks would offer high interest rates to attract deposits and then use those deposits to fund risky loans for rapid growth. The agency has long had similar concerns about brokered deposits.

The FDIC’s scrutiny of brokered deposits mostly dates back to the savings and loan crisis in the 1980s, when some struggling banks used a large amount of brokered deposits to fund risky assets in a failed attempt to survive.

Brokered deposits bring other baggage for the agency. Those funds come to a bank through third parties often not in the bank's market, so they can be quickly withdrawn, and the FDIC has a difficult time marketing those deposits as part of an institution's franchise value in failed-bank acquisitions. Brokered deposits typically are also fully FDIC-insured.

Failed institutions with a lot of brokered deposits "have cost us a lot of money on the back end,” Miller said during the community bank meeting.

But many in the industry have long argued that it wasn’t the brokered deposits that caused banks to fail, but the risky loans they made by using those brokered deposits.

“The funding source didn’t cause the failure, the bad assets caused the failure,” said Meminger. “And when you look at truly managing your balance sheet, brokered funding is one of the best tools available” to use over the long term and “peg exactly where you want to be on the curve so you can manage assets as needed.”

A study released earlier this year by the University of Utah’s Center for Financial Services dove into concentrations of brokered deposits at banks during different various downturns and concluded that regulators have “unfairly linked” brokered deposits to bank failures.

“There are some parts of the country that have excess savings and some banks in other areas that could use those deposits to fund growth,” said the study’s co-author, Dr. James Barth, Lowder Eminent Scholar in Finance at Auburn University and a senior fellow at the Milken Institute. “There should be a level playing field. ... It’s time to treat all brokered deposits the same as deposits.”

The study found that more than 2,500 banks, or 43% of the industry, used brokered deposits totaling $891 billion in 2017. However, those totals of brokered deposits only counted for 7% of total deposits and 6% of total assets.

That’s “hardly ratios to raise the alarm bells,” the study said, which was co-written by Yanfei Sun, a fourth-year Ph.D. student at Auburn University. “We also find that the top 100 banks account for 87% of all brokered deposits in the industry.”

Even Miller at the FDIC acknowledged during their community bank board meeting that “most” banks manage brokered deposits “just fine, and it's part of an overall strategy.”

“But throughout time, there is a linkage between institutions that have used brokered deposits and used high-rate deposits for excessive risk-taking and excessive growth,” she said.

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Deposits CDs Financial regulations Interest rates Community banking Jelena McWilliams FDIC