A change in how regulators view a certain type of deposits could give community banks a leg up to compete against bigger firms for large accounts.
Bank of Central Florida has already taken advantage of the product, called a reciprocal deposit, to offer deposit insurance beyond $250,000. Other community banks may soon follow its lead.
The deposits were vital to the Lakeland, Fla.-based bank's survival from its beginning in 2007, right as the country was plunging into the Great Recession. Commercial customers within the community were scared to put their large deposits into the new bank, fearing they would lose their funds if Bank of Central Florida failed.
Reciprocal deposits allowed bankers to reassure customers that the entire balance of their accounts would be insured, said CFO Robert Kenney. Within 18 months, the bank was profitable. Bank of Central Florida, which had $525 million in assets at the end of the first quarter, reported a balance of $109.9 million in reciprocal deposits.
Congress recently reclassified reciprocal deposits held at banks from "brokered" to "non-brokered" if they total either less than $5 billion or 20% of total liabilities. The reclassification is an important one for banks because regulators view brokered deposits with greater scrutiny. The funds can carry higher insurance assessment premiums and can be restricted at less-than-well-capitalized banks.
The change could incentivize more banks to use the product, which they welcome as a way to stay competitive. But some skeptics worry that increased usage could expose the government's insurance fund to significantly more deposits.
"It gives us the opportunity to go after the bigger clients, where in the past they may have been afraid to put their money with us because we weren't a Bank of America Corp. or Wells Fargo & Co.," Kenney said.
Although reciprocal deposits are popular, they have room to grow in the industry. Currently, 1,170 active banks — or a fifth of total banks — reported a reciprocal deposit balance in the first-quarter. They totaled $48.42 billion, up 83.2% from a low point in 2012 of $26.43 billion.
Banks with between $1 billion and $10 billion in assets held the bulk of the funds, though banks with more than $10 billion in assets have increased their holdings 4.4% since 2015, according to an S&P Global Market Intelligence analysis.
The FDIC insures amounts up to $250,000, and reciprocal deposits allow banks to offer insurance on funds above that cap. The placement bank divides the funds above $250,000 among multiple institutions and receives an equivalent, or reciprocal, amount back from those banks. Each bank records the total amount of the deposit after the placement.
"From the beginning, this was a way for community banks to fund themselves," said Phil Battey, senior vice president of external affairs at Promontory Interfinancial Network. Promontory created the reciprocal deposit product and runs one of the largest networks facilitating their use.
Most of the money within Promontory's network originates locally: 80% of customers using the certificates of deposit product reside within 25 miles of the relationship branch. Battey added that 36% of outstanding accounts are businesses, 32% are government entities and 14% are nonprofits, with the balance made up of individuals or other banks.
From 'brokered' to not
The reclassification is not without risk. By design, the product subverts the deposit cap, exposing the insurance fund to more liabilities and potentially more payouts if a bank fails. When banks with reciprocal deposits have failed, the FDIC fully paid every resulting claim for insurance, according to Promontory Interfinancial Network's FAQs. Former FDIC Vice Chairman Thomas Hoenig criticized the product in late March, saying it underwrites "rent seekers [who] capture the value of the deposit insurance" and that it "annoys him."
The FDIC previously considered the deposits "brokered" because the placement bank acted as an intermediary for the depositor when distributing the funds, according to its 2011 Study on Core Deposits, but the regulator acknowledged they could pose fewer problems than other brokered funds. It added that reciprocal deposits pose "sufficient potential problems" for banks, including reliance on a network to gain access to the funds and the possibility for rapid growth of reciprocated funds that are not based on customer relationships. The FDIC declined to comment for this story.
The "brokered" designation may have discouraged banks from offering reciprocal deposits, according to 2015 research from Sherrill Shaffer of the University of Wyoming's College of Business. In an interview, Shaffer predicted that the reclassification would boost the amount of the deposits or number of banks using them, a sentiment echoed by industry advocates.
"If the stigma of 'brokered deposits' is taken away, I think you'll see some banks jump on them," said Steve Scurlock, director of government relations and public policy at the Independent Bankers Association of Texas, which endorsed Promontory's product. "I'm pretty darn happy that [the bill] finally passed."
Bankers consider them stable
BOK Financial Corp. Chief Risk Officer Martin Grunst also stressed that the deposits enhance customer relationships and carry a different risk profile than other brokered funds. The $1.22 billion in reciprocal deposit balances at Tulsa, Okla.-based BOKF NA, which had $33.23 billion in total assets, grew 30% quarter over quarter but made up only 4.1% of total liabilities.
"We do think of a reciprocal deposit as being a more-stable funding source relative to a regular brokered deposit," he said. "I think most people would."
Research backs up his view. Researcher Mark Flannery, who would later be a chief economist for the Securities and Exchange Commission, found that banks that failed and had reciprocal time deposits gathered through the Promontory network had "substantially and significantly lower resolution costs" in a 2011 paper.
Shaffer found that reciprocal deposits did not lead to increased risk-taking behavior at banks. His research also found that they help manage liquidity and reduce the overall cost of funding.
Both studies found that reciprocal time deposits behave similarly to other core funds when predicting a bank's likelihood of failing.
"From a banker's perspective, I regard the use of this product as part of an overall sound management strategy," Shaffer said. "Congress did a good thing."
Commercial banks, savings banks and savings & loan associations report reciprocal brokered deposits in Schedule RC-O of the call report.
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