The banking industry has taken notice of the news that the Federal Deposit Insurance Corp. plans to change the way it assesses banks with less than $10 billion in assets for deposit insurance coverage. Most of the FDIC's proposed changes are reasonable. But one small provision could spell big trouble for community development financial institutions—and the distressed communities that rely on them.
CDFI banks are financial institutions with a primary mission to serve low-income communities. We make loans to finance housing so that people have a decent place to live and to small businesses so that people have jobs. Our lending revitalizes neighborhoods and has a positive impact that reaches far beyond our direct customers. Moreover, CDFIs are often the only source of credit and financial institutions in impoverished areas.
Since CDFIs serve some of the nation's most economically distressed and credit starved communities, it can be tough for them to attract enough deposits to meet credit demand. Therefore many CDFI banks raise deposits from civic-minded, socially motivated institutions outside our markets, such as state and municipal governments, foundations, local businesses, educational institutions, churches, nonprofits and others. Our experience shows that these community-oriented investors are much more willing to invest large deposits with us if those deposits are insured.
In such cases, our banks rely on reciprocal deposits to provide assurance to customers that deposits above the FDIC-insured threshold of $250,000 will be safe. The reciprocal deposit system enables banks to exchange the portions of large deposits above $250,000 with other banks so the depositor is fully insured. In effect, however, we retain the full amount of the deposits to fund local lending.
As a group, CDFI banks use reciprocal deposits at a rate more than four times the national average. In fact, reciprocal deposits represent nearly 40% of deposits at some of our members.
The FDIC's current small-bank assessment formula, in effect since 2009, recognizes that reciprocal deposits share a number of characteristics with core deposits. Reciprocal deposits are typically local; nationwide, about 80% of reciprocal deposits come from customers located within 25 miles of a bank's location. Banks set the interest rates on reciprocal deposits based on local, not national, market conditions. Reciprocal deposits are also stable; they have a reinvestment rate of more than 80%. Therefore the FDIC's current formula gives positive weight to reciprocal deposits by allowing bankers to subtract them from brokered deposits prior to calculating the adjusted brokered deposit ratio.
But the proposed small-bank assessment would treat reciprocal deposits like any other form of brokered deposits or wholesale funding, failing to take into account their characteristics or benefits. The new formula would substitute a core deposit ratio for the adjusted brokered deposit ratio, so that bankers would no longer be able to differentiate between reciprocal deposits and traditional brokered deposits. This reversal would penalize banks that use reciprocal deposits by increasing their premiums.
The proposed rule's treatment of reciprocal deposits would negatively and disproportionately impact CDFI banks and minority depository institutions. In fact, the proposed assessment would result in more than $600,000 in annual assessment increases based on CDFI banks' reciprocal deposits alone. The FDIC gave no justification for this change in treatment in its proposal.
Under a risk-based assessment system, premiums for each individual institution are supposed to reflect the specific and measurable risks posed by its assets and liabilities. There is no data to suggest that reciprocal deposits increase the risk to the FDIC's deposit insurance fund. In fact, data from two academic studies show that the use of reciprocal deposits during the 2008 crisis had either no effect or a salutary effect on the probability of bank failure. (The studies are "Data-Driven Deposit Insurance Assessments" by Mark Flannery and "Estimated Effects of CDARS Reciprocal Deposits on the Likelihood of Failure" by Alan Blinder and Arun Shastri.)
In sum, while traditional brokered deposits justifiably trigger regulatory concerns about the cost, risk and instability, reciprocal deposits are a different breed.
Perhaps the FDIC's decision to lump reciprocal deposits in with its treatment of traditional brokered deposits was unintentional. Regardless, it should be corrected.
There is a simple fix to the problem: the FDIC should retain the current formula's exclusion of reciprocal deposits from the definition of "brokered" in the future assessment system. In this small piece of a large and complex regulatory proposal, it's actually beneficial to low-income communities to maintain the status quo.
Jeannine Jacokes is the chief executive of the Community Development Bankers Association,
a trade group for banks and thrifts certified as community development financial institutions.