What's missing from FDIC's notice on brokered deposits
The Federal Deposit Insurance Corp. has begun a review of its brokered deposit policies by publishing an advance notice of proposed rulemaking. This is another welcome initiative by Chairman Jelena McWilliams to update the agencies policies in response to rapidly evolving financial markets.
Still, while this step is long overdue, there are areas where the agency could further expand its investigation as it considers updating its approach to brokered deposits.
Since 2008, the FDIC has refused to consider any application for a new bank that would rely on brokered deposits and has put pressure on existing banks to transition to other funding strategies. The time has come to recognize that the role of brokered deposits today is different than when they were first offered in the 1980s. They have become an important source of funding and liquidity for many banks — a trend that will only grow as new technologies develop alternatives to traditional deposits.
Unfortunately, there are a number of important elements of the debate that the agency has failed to consider in the ANPR. Ideally, the ANPR should mention the most important factors relating to uses, risks and benefits of brokered deposits for commenters to consider. That would include, for instance, a look at how brokered deposits are used today and who uses them, an overview of market trends, including new technology, market segmentation and the development of branchless banks and mobile banking options.
Such a discussion should also look at the stability of brokered deposits, including the lack of instances of runs or rapid unanticipated withdrawals; the net cost of brokered CDs compared to core deposits or other deposits when the costs of branches, service centers and advertising are considered; considerations for how brokered deposits have developed into a safe investment comparable to a government security; and the demand for brokered deposits rises in an economic downturn as people flee to safety.
The most useful information in the FDIC’s document is a chart on page 54 that shows that more than half of the failed banks studied over the past decade held no brokered CDs and the other 47.75% held mostly core deposits. Only 12 of the failed banks, 2.25% of the total, held a majority of brokered CDs. This means that brokered CDs could not have played a significant role in the failure of more than 97% of the banks that failed in the past 10 years.
The rest of the ANPR's 88 pages mostly describe a "regression analysis" of the use of brokered deposits by the 530 banks that failed between 2008 and 2017. This study ultimately found a small statistical correlation between brokered deposits and failure but no direct causation. It concludes that banks using brokered deposits must be more aggressive in lending practices for some reason they could not identify. But merely holding brokered deposits cannot cause a bank to make bad loans. As other FDIC studies cited in the ANPR found, the epidemic of bank failures during the Great Recession was entirely due to poor lending by banks that took a deep dive into a bubble of acquisition, development and construction loans and commercial real estate loans.
Aside from this weak correlative data, the ANPR briefly summarizes three main problems with brokered deposits. The first is that the ready availability of brokered deposits enables a bank to make more bad loans. Yet the ANPR does not mention the degree to which it may have happened or what it may have cost. Because so few banks held large amounts of brokered deposits, it could have only happened in a small number of cases. More important, it ignores the much bigger issue of mismanagement. The banks in the ANPR study failed because they made bad loans. It is only coincidental that a few of those banks held brokered deposits.
The second assertion is that brokered deposits are volatile and risky. But, in fact, brokered deposits have developed into the most stable and cost-effective deposits available to any bank.
The third criticism is that brokered deposits increase losses to the FDIC because they have no franchise value if a bank fails. Franchise value refers to the goodwill premium the FDIC sometimes gets when it can sell a failed bank intact to another bank. Yet the ANPR cites no incident where the FDIC could not sell a failed bank because it held brokered deposits. It does not estimate costs to the FDIC in paying out brokered deposits compared to core deposits. It doesn't mention that the market value of core deposits is only about 1%-2% even in good times and was probably less when the market was flooded with deposits from failed banks. Neither the ANPR, nor the earlier studies it cites, mention the difficultly in selling failed banks during the recession because the book value of their assets had crashed and their credit quality could not be trusted. The ANPR doesn't mention that many brokered deposits do have value, particularly if they are long term with below market rates. More important, at the very most this is an argument for adjusting an institution’s insurance premiums. It is not an appropriate basis to restrict the entire industry’s access to a valuable, and for some, a critical source of liquidity.
Omitting any analysis of the use of brokered deposits by banks that did not fail highlights the bias in the ANPR. This analysis would have revealed that for the past 35 years, banks that relied the most on brokered deposits have been among the most highly capitalized and profitable banks in the nation. These banks also have the lowest failure rates of all banks. That makes the blanket statements in the ANPR that brokered deposits increase the risk of failure factually incorrect and misleading.
Another key omission is a discussion of market trends, which is especially important for developing good policies for the future. One of the strongest trends is technology-driven product segmentation and the development of branchless banks. Even traditional branch banks are affected by these trends. To grow their deposit base and minimize losses on traditional checking accounts, many larger banks have begun to reduce branches, invest heavily in mobile technologies that cost less and are attractive to younger customers, and increase their use of brokered deposits. There will always be room for branches and community banks serving customers who want personal service, but many other banks could soon be shifting more to mobile checking, internet savings and brokered deposits. If the ANPR is a guide, the FDIC doesn’t understand this or is making the monumental mistake of ignoring the significance of these trends.
The ANPR is important because it will trigger a much-needed policy review. We hope the discussion will expand to cover all the factors that need to be considered to fashion the best policies.