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FDIC shifts focus to intent when evaluating brokered deposits

The Federal Deposit Insurance Corp. is rethinking how it defines brokered deposits — a process that could bring relief to banks with high concentrations in this funding type, including those with significant financial technology partnerships.

Banks have been keenly interested in their exposure to brokered deposits because significant concentrations increase the amount they have to pay for FDIC insurance and can invite more intense regulatory scrutiny. Banks acquire brokered deposits through third-party companies or brokers.

In December 2018, the FDIC issued a final rule that allowed well-capitalized banks to avoid the brokered deposit designation for reciprocal deposits below a set limit. In the third quarter, banks reported $30.1 billion of reciprocal deposits, a 32.88% year-over-year increase. Reciprocal deposits allow banks to offer FDIC insurance in excess of the $250,000 limit per account by putting amounts beyond the limit in a network that places the funds at another bank, which then puts a matching amount back into the network.

Among the 20 largest banking units by total assets, Goldman Sachs Bank USA reported the highest concentration in the third quarter with 38.95% of its deposits meeting the brokered definition. The median for all 2,065 banking units that reported brokered deposit data for the third quarter was 4.58%.

With the FDIC reconsidering its definition of brokered deposits, banks might reconsider certain funding types. On Dec. 12, the banking regulator issued a proposed rule that would tweak how it classifies brokered deposits. The day prior, FDIC Chair Jelena McWilliams delivered a speech that opened the door to completely eliminating brokered deposits as a scrutinized class of funding. Congress could consider repealing the law that requires regulatory evaluation of brokered deposits, replacing it with a law that restricts asset growth for banks "that are in trouble," she said. Congress passed the law that governs brokered deposits in 1989 following the failure of banks that funded rapid asset growth with brokered deposits.

For the near-term changes in the proposed rule, McWilliams enumerated four goals: encouraging innovation so banks can better serve customers; pursuing a balanced approach to abide by the letter and spirit of the law; minimizing risk to the FDIC's insurance fund; and establishing a consistent, efficient administrative process. The proposed rule suggested new definitions for key phrases when evaluating brokered deposits, such as clarifying the definition of "deposit broker." The clearest change was a new standard for broker-dealers who manage client accounts and might look to "sweep" cash not invested in the market into a deposit account. The proposed rule stipulates that as long as the cash sweep equals less than 25% of the client's assets under management, the deposits will not count as brokered.

The proposed rule also envisions a change to the term "facilitating," which regulators have interpreted broadly to include any third parties that connect banks with depositors. The proposed rule stipulates specific activities to qualify as "facilitating." For example, if the third party has the authority to close the account and move the depositor's funds to another bank, it would qualify as facilitating deposit placement.

"The underlying theme is we're going to go from process to intent, and I think that's really important because technology has changed the process so much," Sandler O'Neill & Partners Chief Balance Sheet Strategist Scott Hildenbrand said in an interview.

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Banks that have partnerships with financial technology companies to offer deposit services have reported particularly high levels of brokered deposits. For example, The Bancorp Inc. has a relationship with Varo Money Inc. that enables FDIC insurance on the fintech's deposit-gathering platform. The Bancorp, which has numerous nonbank partnerships, reported a brokered deposit concentration of 78.30%.

Hildenbrand said fintechs should be able to qualify for the proposed rule's "primary purpose" exemption. Third parties that can prove a primary purpose beyond placing deposits can qualify for an exemption, making the funds they place non-brokered. Still, he said the proposed change might not encourage banks to rush into fintech deposits that were previously classified as brokered. The more likely effect is that banks with significant concentrations of brokered deposits will see a benefit.

"I don't think you'll see major changes in the brokered world, but I do think people who were getting dinged for having brokered will get some relief," he said.

Brett Rabatin, a senior research analyst for Piper Jaffray, also said the proposed rule is not a game-changer for how banks think about deposits. Some banks might gain the ability to raise new funds, but it will not change their central goal of winning sticky deposits, he said in an interview.

"I think most banks will tell you that kind of stuff is funding for a portion of the balance sheet, but it's not what they're excited about doing," Rabatin said. "They want to grow core deposits."