The Federal Deposit Insurance Corp.'s brokered deposit rule proposal will likely face harsh pushback from the banking industry, which is already expressing criticism before the comment period starts.
On July 30, the FDIC board voted to approve a notice of rulemaking that would primarily overhaul the agency's most recent brokered deposit rules enacted in 2020. The 2020 rule, which banks currently follow, was a major update and clarification of brokered deposit-related matters since the last formal amendment in 1992. It allows banks to define more deposits as core, including those originated by fintech partners.
The new rule, to a large extent, reverses the 2020 final rule, said Jason Cave, a senior consultant at Patomak Global Partners and a former FDIC official. The far-reaching proposal could impact virtually all community and regional banks and their funding, in addition to fintech partnerships or banking as a service (BaaS), Cave said.
"One of the issues is that there's so much focus on BaaS that can lead somebody to think that that's it," Cave said in an interview. "I think it's important to realize that the actions by the majority of the FDIC board go well beyond BaaS."
Under the new rule, certain deposit categories currently viewed as core will need to be reclassified as brokered, and the amount will be substantial given the broad scope of the changes, industry experts said.
For instance, if a broker/dealer places over 10% of its assets under management at a bank, the entity would be deemed a deposit broker, whereas the current threshold is 25%. If a bank pays a fee to a third party for deposit placement, the party will be counted as a deposit broker, whereas currently, compensation alone is not a determining factor. The new rules will also narrow primary purpose exceptions, which are clauses that banks commonly use to exclude certain deposits brought in by a third party from being counted as brokered.
"It's broad and it's significant, and I think it will have a meaningful impact if it's adopted as proposed or even substantially as proposed," said Jason Cabral, a partner at Gibson Dunn & Crutcher LLP. "It's across the board — banks of all sizes, bank-fintech partnerships, and it potentially flows through even to consumers."
The FDIC will be collecting comments for 60 days after the rulemaking is posted in the Federal Register. While the outcome of the process is still unclear, banks are advised to get familiar with the proposed changes.
"For existing arrangements where there may be a concern about how the deposits would be treated under the rule, I would advise the clients to have a watchful eye on developments, but I wouldn't necessarily make any immediate changes," said William Stern, a partner at Goodwin Procter LLP.
However, Stern thinks banks should be mindful of changes as a result of the proposal.
"I do think that for new arrangements, it may be prudent to try to fit them into the new framework to the extent possible," Stern said.
Consequences of more brokered deposits
Brokered deposits are oftentimes linked to higher flight risks and hence subject to more regulatory limitations compared to core deposits.
The main ramification is that banks have to ask for FDIC permission to continue to use brokered deposits if they are no longer considered well capitalized.
"And the FDIC might say yes. They might say no. They might take a while," Cave said. Being declined can put the bank in a difficult situation, said Cave, who was a deputy director at the FDIC monitoring complex financial institutions and advised on failed bank resolutions.
"That bank has to, at the worst time, look for other funds or start to sell assets. And it leaves the FDIC resolution people limited options. So they're in a rush now, and it shortens their time to find a buyer," Cave said.
Banks with over $10 billion in total assets will face more regulatory consequences under the new rules, said Casey Jennings, a partner at Seward & Kissel LLP. First and foremost, the amount of brokered deposits is partly used to determine the assessment fees to the FDIC insurance fund. The more brokered deposits, the higher assessment fees.
Large banks are also subject to the liquidity coverage ratio requirements, which require them to hold more high-quality, liquid assets against brokered deposits, because of the assumption that those deposits are more likely to cause cash outflows over a 30-day stress period. Brokered deposits are not counted as a source of stable funding, so large banks have to find other funding to maintain the net stable funding ratio, Jennings said.
For small banks that are under $10 billion in total assets and well-capitalized, there are no major restrictions to use brokered deposits, but there is a pronounced regulatory stigma. A large number of brokered deposits makes examiners more cautionary about inadequate risk management, Jennings said.
"From our understanding by talking to banks, their examiners really turn the screws on when it comes to high use of brokered deposits," Jennings said.
More work to banks, FDIC
The changes around filing for primary purpose exceptions would add more workload to banks, industry experts said.
According to the Federal Deposit Insurance Act's definition of "deposit brokers," exceptions are available if the third-party entity's main business is not placing funds for depository institutions. For instance, prepaid card companies that collect deposits but mainly for payment transaction purposes can make a case that those deposits are non-brokered.
Currently, deposit accounts enabling payment transactions are automatically non-brokered, but the new rule will eliminate this designation, meaning parties relying on the "enabling transactions" exception will have to go through an application process, said Matthew Bornfreund, a partner at Troutman Pepper.
"It is hugely burdensome, and there's also a question of whether or not the FDIC has the capacity to handle the volume of applications that are going to come in with all the companies that are currently relying on that exception," Bornfreund said.
The proposal also requires that only depository institutions can file for primary purpose exceptions, whereas currently, service providers and partners can facilitate this process, said Reid Thomas, chief strategy officer of Ampersand, a firm that connects corporate depositors with financial institutions.
"It layers more cost and complexity on the bank," Thomas said.
Hastened process, outdated data
Due to a tight schedule, odds are low that the final rule can take effect before the presidential election, and which party will lead the next administration adds uncertainty to this rulemaking, the advisers said.
Brokered deposits have not been a distinct partisan matter, but the idea of modernizing the treatment of brokered deposits was generally seen by the Democrats as a loosening of regulations, so they tended to be more skeptical of the 2020 rule, Bornfreund said.
Considering that the two Republican FDIC broad members, Travis Hill and Jonathan McKernan, were opposed to the rule, it is more likely that the rule will not be adopted as written if a Republican chairs the FDIC, Jennings said.
Some criticized that the rulemaking is based on outdated data that no longer reflects the current deposit dynamics. At the July 30 board meeting, McKernan noted that the proposal does not offer sufficient evidence to elaborate the risks in the brokered deposit categories that the rulemaking aims to address, and how reclassification can tackle those concerns.
The FDIC initiated a request for information (RFI) on deposits in the meantime. It shows that the FDIC recognizes that it needs more information about the current status of different subsets of deposits, Cave said. The process would have better sequencing if the FDIC could collect the information first, before they act on the proposal, because there's a lot of granularity on various deposit accounts that the FDIC may not have a good handle on, Cave said.
Still, Cave praised the RFI, calling it "an appropriate step" to update the agency's understanding on deposits after the bank failures in 2023.
"I'm advising all of my clients to really give the FDIC as much information as they can on the RFI, to help the FDIC do a better job on supervising deposits," Cave said.
It is not out of ordinary that agencies try to push through their agenda before a presidential election. The 2020 rule was also finalized in an election year. However, the industry showed more appreciation for the FDIC providing clarification on a broad range of issues related to brokered deposit. Between 1992 and 2020, this matter had been addressed by the FDIC mainly in the form of questions and answers, or so-called FAQs, instead of formal rulemaking.
"There were comment letters requesting changes, but there was not kind of an outcry, like there is today," Jennings said.