Regulators should re-examine how they classify deposits, or more banks could be classified as troubled.

That was the view of a panel on the Transaction Account Guarantee program at American Banker's Regulatory Symposium. TAG will likely expire as scheduled on Dec. 31. Executives of community banks fear that if Congress refuses to extend it, many depositors will withdraw funds that surpass the Federal Deposit Insurance Corp.'s insurance limits.

That's why regulators should review deposit classifications, said Joshua Siegel, a managing principal at StoneCastle Partners.

Regulators are ill prepared for the aftermath of a TAG expiration, Siegel said.

"Regulators are only now catching up and only now modeling on what will happen if TAG goes away," said Siegel, whose firm invests extensively in community banks. "The FDIC took a very lazy stance when Congress" — through the Dodd-Frank Act — "requested a study on brokered deposits."

FDIC spokesman David Barr declined to comment.

Specifically, the FDIC and other federal regulators need to revisit which deposits are classified as brokered and which ones are classified as core, industry observers said. Some community banks may be unfairly punished for holding onto deposits that really should be termed as core deposits.

"There are deposits that are highly volatile today [that are] considered core," Siegel said. "And then there is a 10-year CD that's considered brokered and is frowned up on by regulators."

An unfair classification could lead regulators to question some small banks about potential safety and soundness issues, said Jim Fleischer, a panelist and lawyer at Silver Freedman & Taff.

"The more core deposits an institution holds, the healthier" it is considered, Fleischer said. "The more brokered deposits and CDs, then the regulators say those are volatile."

Bankers are concerned. Robert Catanzaro said he is worried that such a situation could befall Independence Bank in East Greenwich, R.I., where he is the chairman and chief executive. About 12% of Independence's deposits are TAG-related, and he said the $66 million-asset bank could lose a good chunk of those funds when the program expires.

"TAG has been really important to us," Catanzaro said in an interview. "It has helped us compete against the bigger banks."

A local municipality recently yanked about $500,000 out of Independence. Though the locality gave no explanation, "it didn't help that the future of TAG is uncertain," Catanzaro said.

Federal Home Loan banks could provide liquidity for small banks, but FHLB collateral requirements are very strict, says Ron Paul, the chairman, president and chief executive of Eagle Bancorp in Bethesda, Md.

There is also a limited group of banks that could apply for advances. Independence does not consider the advances an option, because most of its assets are U.S. Small Business Administration loans, Catanzaro said. Home loan banks do not accept SBA loans as collateral.

Proponents of eliminating the TAG program have said that small banks could retain corporate and municipal customers by using private-sector programs that allow an individual bank to take in a $1 million deposit and then spread the funds evenly across four or five banks so that entire amount is then insured by the FDIC.

Catanzaro said that, since the financial crisis, the FDIC is much more likely to view those deposits as brokered, which it turn increases a bank's deposit premiums.

Independence is an active user of the Certificate of Deposit Account Registry Service offered by Promontory Interfinancial Network. But the bank scaled back use — to $6 million from $22 million — after examiners said that the deposits were risky.

"We tried to stress to the FDIC that these deposits are all originated locally," said Catanzaro, adding that one customer lives on his street. "It is not hot money."

Alan Kline contributed to this story.

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