Brokered deposits add new wrinkle to Silvergate saga

The ancient Greek myth of Cassandra goes something like this: The daughter of King Priam and Queen Hecuba of Troy (and sister of the Trojan hero Hector) was very beautiful and charming, and through no fault of her own caught the eye of Apollo. Apollo, being the god of the sun, light, music, poetry and lots of other things, wanted to marry Cassandra and to sweeten the deal gave her the gift of prophecy — the ability to see the future. What happens next is subject to some debate, but Cassandra either intentionally or unintentionally slighted Apollo's advances, which is a big no-no in Greek mythology. Because Greek myth rules forbid a god from taking back a gift once bestowed, Apollo afflicted Cassandra with a curse — no one would ever believe Cassandra's prophecies.

I wonder if Federal Deposit Insurance Corp. Chair Martin Gruenberg feels that way now. Way back in 2020, when the FDIC board was voting on changes to the agency's brokered deposit rules, Gruenberg warned that the then-proposed changes would allow a bank to "rely for 100% of its deposits on a sophisticated, unaffiliated third party without any of those deposits considered brokered." The risk of that arrangement, he said, was that a bank whose capital levels fell into dangerous territory could continue relying on a single counterparty for the entirety of its deposit base, effectively creating "an end-run around the statutory prohibition on less-than-well-capitalized banks receiving brokered deposits."

If you don't spend a lot of time thinking about brokered deposits or even knowing what they are, you are very far from alone. The gist of it is this: You and I deposit our money in a bank, and we get whatever return we get. But if you have lots of deposits that you can move all at once, you can jump from bank to bank seeking the highest rate of return. Those are brokered deposits, and what makes them different is that a bank can't necessarily rely on them to stick around, particularly when the going gets tough — that's why they're sometimes called "hot money." 

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The FDIC has rules around which banks can accept brokered deposits and what a bank has to do to make up for their loss if it accepts them and they go elsewhere. That changed in 2020 when then-FDIC Chair Jelena McWilliams and her allies on the board fleshed out a "primary purpose exemption" from the brokered deposit rules that would allow more types of deposit arrangements to be exempt from those "hot money" restrictions.

The rationale behind those changes was that fintechs and other newfangled firms sometimes develop exclusive deposit-taking arrangements with a bank, and because the nonbank counterparty's primary purpose in the relationship isn't maximizing deposit return, those deposits shouldn't be considered "hot" in the same way traditional brokered deposits are because they're less likely to be lured away by higher returns elsewhere.

But, as it turns out, there's more than one way to lose a deposit. If, for example, one of those exclusive banking arrangement partners is itself taking customer funds in exchange for cryptocurrency and those customers decide they'd rather have their money back than have their cryptocurrency, the bank is suddenly experiencing a run. That's not a problem if the bank has a broad and diverse deposit base, but if it's not, then it can be a problem, and something like that seems to be what happened to Silvergate Bank late last year.

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This begs an important question with a vexingly nebulous answer: Would anything have been different for Silvergate if the brokered deposit rules had never been changed back in 2020? Brian Brooks, who was acting comptroller of the currency when those rules were adopted, says no — in fact, he says, Silvergate's use of brokered deposits went up when the rest of its deposits were flowing out. As of last June, neither FTX nor its subsidiary Alameda Research had applied for or received a primary purpose exemption, so that gives some credence to Brooks' point.

But that hasn't stopped critics from insisting that there is smoke coming from the brokered deposit rule, and that concern is justified when one looks at which companies have acquired an exemption. The crypto exchanges Coinbase and Paxos have gotten them, as have lots of broker-dealers, PayPal, cannabis deposits and other not-so-mom-and-pop operations. Seems like whomever the intended beneficiaries of the primary purpose exemption might have been, there are a lot of bedfellows in that exemption that might not have been intended.

The ultimate question is whether the Silvergate run is a confluence of unique factors that could only apply to one bank at one time, or whether it is illustrative of a broader risk that is replicable by other institutions and at a scale that could create a risk to financial stability — or whether the conditions are ripe for such a risk to accumulate over time. I don't know the answer to that question, but fortunately it doesn't really matter what I think. But it very much matters what Martin Gruenberg thinks about brokered deposits today, and how different it is from what he said he thought about them in 2020.