Banks adapted and now what? FDIC’s brokered deposit proposal rattles industry

The FDIC’s latest oversight of fintech and bank relationships, this time a proposal for brokered deposits, sometimes referred to as “hot money”, leaves many in the financial services industry critical that regulators are targeting the wrong issues even as they aim for fairness in modern banking.

And, some critics add, Washington with piecemeal action is delaying a wholesale review of equitably governing expanding fintech and banking relationships.

Plus, the concerned parties stress, the rule change proposal, which attempts to rewrite changes made as recently as 2020, will add compliance and policy burdens to community banks and smaller regional operators especially. Banks and credit unions have responded to market demands to embrace the digital migration and on-demand consumerism with partnerships that allow them to compete for customer prospects, deposits, loans and other revenue opportunities.

Regardless of size, the financial services industry at large is bristling at this change so soon after the 2020 adjustments, Kelly Brown, chairman and CEO of Wisconsin-based deposit and treasury management specialists Ampersand, told BAI.

“There hasn’t been a sufficient amount of time to test those 2020 rules,” said Brown, whose Ampersand connects nonprofits, real estate concerns and others who have deposit needs with financial institutions. “Think about the distortions in the economy since those rules have been in place, namely the pandemic and government stimulus, loan forbearance, unusual liquidity and deposit flows. It’s not been a typical backdrop to test those rules.”

Brown said she expects the banking and tech industries to produce a record number of comment letters to the latest FDIC proposal, although other observers have noted the shorter-than-usual comment period may limit submissions.

What is the FDIC proposing?

In late July, the FDIC released its proposed revisions which attempt to tighten restrictions on brokered deposits. The agency said the rewrite reflected the FDIC’s experiences in the few years since a round of changes to the same rules were crafted in 2020, especially considering the regional bank failures of 2023.

But the timing also appears to link to this year’s high-profile bankruptcy for Synapse Financial, which has raised the regulatory stakes around fintechs and their relationships with more traditional banks and credit unions. Synapse, a bank and tech intermediary for customers including Evolve Bank & Trust, filed for Chapter 11 bankruptcy protection in April. That disrupted business for some partners, freezing select accounts.

In fact, FDIC officials named the Synapse situation in rolling out the brokered deposit proposal.

FDIC Chairman Martin Gruenberg said in his accompanying statement, the latest proposal addresses “the fundamental relationship between a bank, a depositor and a third-party intermediary, and the risks the relationship may pose as illustrated by the recent failure of the nonbank deposit broker Synapse Financial.”

And Guenberg added, “The changes would also help strengthen the important prudential protections of the brokered deposit rule required by statutory restrictions and reduce the very serious risks that brokered deposits pose to less than well-capitalized IDIs [Insured Deposit Institutions] and the Deposit Insurance Fund.”

The proposal largely reverses what in 2020 had narrowed the definition of brokered deposits. And it modestly broadens the initial scope to include more deposit arrangements regulated as brokered deposits.

Partner David F. Freeman, Jr and team at Washington law firm Arnold & Porter said in a summary the FDIC’s action signals the current staff’s view that many brokered deposit arrangements fundamentally are less “sticky” than core deposits, or less likely to remain at any given bank in a fluctuating interest rate environment.

The legal team highlighted this language as well: The FDIC notes that “less than well-capitalized IDIs may rely on less stable third-party deposits for rapid growth” or “as their condition is deteriorating,” pose risks to the safety and soundness of IDIs and financial stability more broadly.

To restrict such deposit-brokering activities, the FDIC has proposed to effectively shift the regulatory and reporting burden for deposit brokering activities back to IDIs. This, the legal team and financial services observers have stressed, may increase costs for IDIs and recalibrate their role in the brokered deposits regulatory framework.

In addition, the proposal would redefine “deposit broker” to include entities receiving fees for deposit placements, which rewrites the primary purpose exception criteria and introduces a new broker-dealer sweep exception.

The proposal also updates the application process for primary purpose exceptions, requiring that insured depository institutions are the parties submitting applications, rather than their nonbank partners. Under the most recent 2020 rule, a broker is exempt if less than 25% of its assets under administration for customers are placed with depository institutions. The proposal would lower that threshold to 10%, reducing the number of intermediaries that qualify for the exception.

Some of the direct changes Insured Deposit Institution’s (IDIs) can expect to see include:

• An increase in the amount of deposits classified as brokered deposits;
• Potential changes to affected IDIs’ Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) for those IDIs subject to those requirements;
• Revisions to policies and procedures relating to deposit placement arrangements; and
• An increase in the number of brokered deposit PPE applications.

American Bankers Association President and CEO Rob Nichols, in a statement, expressed concern that the sweeping revision would restrict liquidity access and penalize banks in their pursuit of funding sources “that enable them to meet the needs of their communities.”

Of course, addressing how banks source deposits is not new. Congress first directed banking regulators to address brokered deposits in 1989 with the passage of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), a response to the 1980s savings and loan crisis.

Rethinking how we look at deposits?

For Ampersand’s Brown, the resource burden on community institutions and banks and credit unions already in flux is top of mind, but so is what she believes is an outdated supervisory view of how financial services must respond to a shifting landscape.

“Community banks have put a lot of resources into BaaS developments over time because their communities and customers demanded it, and of course that doesn’t come at the sacrifice of pursuing sound deposits,” she told BAI. “But why not consider an addendum to the rules in place and be more specific to certain fintech deposits? We really need a new language in our business.”

She emphasized that the sometimes-lazy label of “hot money” is not doing the industry and its regulators any favors. Brown recalls that the post-mortem on the 2023 Silicon Valley Bank run that risked larger industry contagion revealed its “stickier” deposits were sourced by means that would fall under regulatory definitions of brokered “hot money.”

And, from her own firm’s point of view, “brokering” long-term relationships between, for instance, a nonprofit’s deposit and treasury management needs, including digital features, and the competing community banks who might best meet those needs, doesn’t fit the “hot money” description that a rule change covers. The same situation is often created for title companies or property management firms, Brown notes, by way of stressing that she believes the FDIC’s one-size-fits-all reaction to fintech’s growing pains is impeding the wrong stakeholders.

“The world is changing. Complete reliance on local bank and local deposits, those days are gone. Liquidity is elsewhere and fintech is one type,” Brown says. “Let’s focus on enhanced reporting, how funds are managed, the nature of bank and fintech relationships, the due diligence behind those relationships, AML, concentration risk. I get that the FDIC is trying to provide clear guidance, but they first need to ask, What’s the problem we are trying to solve?”

But because business must continue, BAI’s Chris Boersma, who helps lead the compliance and policy product team, stresses that banks and credit unions should expect supervisory attention to continue. That means institutions must strategize accordingly.

“We can expect to see more regulation and guidance in this area as these types of third-party deposit relationships continue to grow,” Boersma says. “Institution’s need to become or stay diligent on their third-party risk management oversight because you can expect to see these types of relationships reviewed by examiners on a consistent and thorough basis.”

Rachel Koning Beals is Senior Editor at BAI.