Brokered deposits aren't 'hot money'

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Opponents of the Federal Deposit Insurance Corp.’s brokered deposit revamp tend to use terms like “hot money” and criticize how community banks like mine fund themselves when our customers don’t have enough deposits to support loan demand.

They allege that healthy banks that hold nonretail deposits for funding are taking risks that could lead to costly bank failures. Missing from this criticism is that nonretail funding, and even “classic” brokered deposits, are not some balance sheet disaster waiting to happen. And it doesn’t actually have a correlation to unsafe banking practices.

Efforts to modernize brokered deposit regulations are being led in Congress by Sen. Jerry Moran, R-Kan., as well as at the FDIC by Chairman Jelena McWilliams. Arguments against those efforts are often centered on the false notion that classic brokered deposits are expensive and prone to flight.

However, many community bankers know from experience that a local retail deposit can be costlier and less sticky than a brokered deposit. Other deposits don’t have the built-in predictability of a brokered, term Certificate of Deposit or offer the same protection against changes in interest rates.

In fact, retail CDs can pay an early withdrawal fee and leave the bank faster than a brokered CD — which has contractual requirements. Non-CD retail deposits can disappear instantly.

By not taking into account these realities, or acknowledging that deposit markets and deposit gathering strategies have changed significantly since the regulations were written in the 1980s, the critics of reform are doing community banks like mine a disservice.

However, banks should not be allowed to take on unsafe and unsound liquidity risk. Rather, I am pointing out that the perceived risk of “classic” brokered deposits may not be accurate, and at the very least isn’t so black and white in today’s banking environment.

It is important that community banks have a diverse set of funding sources. I know it’s critical for my bank. We operate in a low- and moderate-income community that doesn’t have the deposit base to meet all of the local funding needs. Because of this, we rely on a mix of core, brokered and wholesale funding, which for us is both cheaper and more predictable. Access to diverse sources of funding allows us to serve our community.

The brokered deposit regulations that penalize banks for turning to outside or modern sources to supply their liquidity needs also exacerbate the problem that the regulations were intended to fix — costly bank failures that damage the Deposit Insurance Fund.

The bank failures during the savings and loan crisis were the result of poor interest rate risk management in the face of high interest rates and deregulation; incompetent and criminal mismanagement; and investing in risky assets in an attempt to grow out of problems.

Deposit brokers were placing funds in already troubled institutions, and so were able to demand a higher rate. But rather than focusing on what drove those institutions into troubled status, which is multifaceted, the focus was put on the product that many used to grow their way out of trouble.

As some academics have pointed out, the FDIC’s study that supported the brokered deposit regulations and determined that correlation meant causation is flawed.

A study on brokered deposits published in 2018 by the David Eccles School of Business at the University of Utah concluded that it wasn’t brokered deposits that were the problem at troubled banks but “the use of any funds obtained by troubled banks to acquire too risky assets in an attempt to grow their way out of their troubles.”

“In other words, the regulatory focus is misplaced,” the study said. “There is likewise no convincing empirical evidence to show that brokered deposits increase the cost to the FDIC when resolving bank failures.”

I agree with the academics — that risky growth was the biggest contributor to the bank failures in the 1980s. But in more recent years, regulations put in place to address those problems are leading to a stigma and restriction of brokered deposits at healthy banks, which has the unintended effect of creating liquidity issues by limiting funding. The problem is worsened by the use of an outdated and overly broad interpretation of who is a deposit broker, and thereby, what is a brokered deposit.

Fortunately, Congress and the FDIC have an opportunity to remedy the problem. And stakeholders should not be resisting a rethink of brokered deposit regulations.

Rather, they should be thinking about what the appropriate guardrails are to mitigate the challenges that the brokered deposit law was put in place to address and how to apply those guardrails to a banking system that has evolved in the last 30 years.

A good start is not to focus on a specific type of funding that was perceived to be risky decades ago, but on how a bank is managing itself, given its unique business model and customer base.

Rapid growth, risky investments and using short-term funding to make low-rate, long-term loans is what led Congress to act. But those are factors that fall on the asset side of the balance sheet, which is where the attention should be.

Brokered deposits have been the fall guy for far too long. Reform is long overdue.

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Deposits Consumer banking CDs FDIC Community banks Liquidity Crisis Management