BankThink

A simple fix to brokered-deposit battle

The American Bankers Association recently released a report from a major law firm detailing the legislative history of the Federal Deposit Insurance Corp.’s battle against bank purchases of deposits from money brokers, continuing a policy debate that began over 30 years ago when I was chairman of the FDIC. The ABA report suggests that over time the FDIC may well have gone further than necessary in addressing the underlying problems with the practice.

I believe the ABA report is responsible and helps illuminate a possible solution to the issues that have arisen with the FDIC’s rules. That said, I’m concerned that the rhetoric of some bankers paints the FDIC’s restrictions on brokered deposits as antiquated vestiges of a bygone era of no value in today’s rapidly evolving internet era.

Let’s take a quick look at the origins of the restrictions in order to better understand the problem and a possible solution. Deregulation of interest rates in the 1980s gave rise to the practice of money brokers raising vast sums of money and bundling the funds for sale to the banks and thrifts that bid the highest prices, generally those that had the highest risk profile. The then-$100,000 limit on deposit insurance flowed through to each of the thousands of investors in the money broker, allowing hundreds of millions of dollars to be placed by the deposit broker fully insured in each bank.

As the bank and thrift failure rate began its dramatic rise, we found an increasing number of failed banks and thrifts had large amounts of fully insured brokered funds. We concluded we had to take strong actions to stop this massive abuse of the deposit insurance system which was under siege.

We addressed the problems on every available front, but our most controversial action was adopting a regulation eliminating “pass-through” deposit insurance coverage on bank deposits from money brokers. In short, we treated the broker as the depositor, not the broker’s customers.

Regrettably, a federal appeals court sided with the money brokers and ruled that the FDIC did not have the authority to interpret its law in this manner. We asked Congress to help us by eliminating flow-through deposit insurance but we were outgunned politically. The floodgates sprang open. Money brokers raised tens of billions of dollars, collecting fees from investors, and placed the money in troubled banks and thrifts, collecting placement fees. They frequently required the recipient banks and thrifts to purchase junk bonds issued in corporate takeovers arranged by the money brokers and their friends. This scam cost taxpayers and insured banks tens of billions of dollars in the savings and loan fiasco.

During the 1980s, the FDIC was focused on eliminating purchases of “hot” money by high-risk banks and thrifts paying above-market rates. The ABA study shows that over the years since then, the restrictions on banks using brokered funds expanded from being targeted on “problem” banks to a much broader universe of banks.

Today, it appears the FDIC may be attempting to limit purchases of brokered funds by non-problem banks even when the funds are priced at market interest rates. If true, the FDIC may want to reconsider the policy, narrow its focus to higher risk banks — those with Camels ratings of 3, 4 or 5 — and rely on its supervisory powers to identify and correct problems that crop up at nonproblem banks.

That said, banks, including highly rated ones, that rely extensively on brokered funds should be cautious. Brokered funds tend not to be as loyal and stable as funds raised directly from bank customers located in the bank’s community. If a bank’s condition deteriorates, funds purchased from investors without loyalty to the bank are more likely to flee.

All banks, including those that make little use of brokered funds, should participate in this debate. We learned during the banking and thrift crises of 1980-1992 and the senseless panic of 2008-2009 that even the best of banks will be forced to bear the cost of any necessary government cleanup.

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Deposits Consumer banking Policymaking Financial regulations FDIC
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