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WASHINGTON — Industry experts are expressing concern about the Federal Deposit Insurance Corporation’s recent proposal that would expand the definition of brokered deposits, also known as “hot money,” and likely prevent banks from holding them.
The proposal would significantly overturn a 2020 Trump-era FDIC rule that narrowed the definition of brokered deposits, and expand the original scope slightly to further expand which deposit arrangements would be regulated as brokered deposits. be.
Other significant changes in the proposal include redefining “deposit broker” to include entities that receive fees for deposit placements and revising the principal purpose exception standard to introduce a new broker-dealer sweep exception. This includes things such as. The proposal also updates the application process for the principal purpose exception, requiring insured depository institutions themselves to submit applications, rather than their nonbank partners. The latest 2020 rules exempt brokers where less than 25% of their assets under management for their clients are in depository institutions. The proposal would lower that threshold to 10%, reducing the number of intermediaries eligible for the exception.
The banking industry has expressed concern about the proposal. Rob Nichols, president and CEO of the American Bankers Association, called the measure punitive and unjust.
“This sweeping measure would limit access to sources of liquidity while also punishing banks for pursuing funding sources to meet community needs,” Nichols said in a statement after announcing the proposal. said. “Given the pending changes in FDIC leadership, we question the need to proceed with an unusually short comment period on a series of unrelated regulatory changes that clearly lack consensus support within the FDIC. ”
Congress first directed bank regulators to crack down on brokered deposits in 1989 by passing the Financial Institutions Reform, Recovery, and Enforcement Act (often abbreviated as FIRREA).
Matthew Bornfreund of Troutman Pepper said that such “hot money” (as it came to be called) was considered by skeptics to be one of the main causes of the savings and loan crisis of the 1980s. states. Before the Internet, he said, deposit brokers held consumers’ savings and offered to “shop” them from bank to bank in pursuit of the highest interest rates possible.
“Back then, it wasn’t really possible for individual savers to shop around the country to find the best interest rates,” Bornfreund said. “Now you can just go online and deposit your money anytime, anywhere in the country, anywhere you want.”
FIRREA defined a deposit broker and restricted banks from receiving brokered deposits if they were less than fully capitalized. Businesses that are deemed suitable but are not sufficiently capitalized may receive brokered deposits with exemptions approved by the FDIC. The law did not clearly define brokered deposits, but rather classified deposits placed by deposit brokers as brokered deposits.
“From 1989 to 2020, the FDIC has determined that based on a series of interpretations and guidance issued by depositor groups…and if you have questions about whether your deposits are brokered deposits, I needed to confirm that.”There are all these different opinions.” “The purpose of the 2020 rulemaking was to provide very clear guidance on what a deposit broker actually is.”
The 2020 rules included carve-outs in favor of third parties that partner with banks. The key carve-out was the exclusion of “exclusive deposit placement arrangements” from the definition of intermediation. Although not explicitly specified in the regulations, this carve-out defines a deposit broker as someone who does business with more than one bank. Therefore, under the 2020 Standards, if a party does business with only one bank, that party will escape classification as a deposit broker under the 2020 Rules.
“That changed with the (recent) proposal,” Bornfreund said. “From ‘more than one bank’ to ‘one or more banks,’ essentially removing the entire exception.”
Another carve-out in 2020 was deposits used to activate payment accounts. This includes credit card products or credit card products where funds are temporarily held in a bank account before moving to the destination recipient, usually within 1-2 days, without earning interest or seeking a better rate. App included. The new proposal would remove this exception as well.
The FDIC’s list shows that several prominent companies have applied for principal purpose exceptions in various business areas. This includes the largest banks, crypto exchanges, and fintechs. Bornfreund said more companies will become subject to the brokered deposit rules until the exclusive deposit placement exception and payment exception are repealed.
“There are a lot of fintech companies that are going to be hurt a lot by this,” Bornfreund said.
Opponents of the 2020 rules, particularly the FDIC’s current chairman, Martin Gruenberg, argue that the current standards pose undue risks to the financial system.
“Under this change, banks can rely on unaffiliated sophisticated third parties for 100% of their deposits without any intermediation,” Gruenberg wrote in 2020. said. “The bank may be less than adequately capitalized and still be dependent on its third parties.” The party deposited 100 percent of the funds in deposits that are not considered brokered…The bank (Also) multiple “exclusive” third party relationships may be formed to fund those deposits without being considered brokered. ”
FDIC Vice Chairman Travis Hill, a former Trump administration FDIC aide and lead author of the 2020 rule, criticized the recent proposals for broad and sweeping changes, complicating the definition of brokered deposits and He argued that it was imposing an unreasonable burden on the government. .
Some, like Jonah Crane of Claros, argue that the proposal is overly tailored and fails to adapt to the evolving customer interactions with financial services.
“The brokered deposit proposal also ignores a wealth of recent evidence that deposits raised through fintech partnerships are actually very stable,” Crane said. “Instead, they cite the tragic situation at Synapse, which holds many lessons for banks and regulators alike, including whether deposits raised through fintech partners should be intermediated. It has nothing to do with it.”
Fintech intermediary Synapse Financial Technologies filed for Chapter 11 bankruptcy in April 2024, citing an $85 million shortfall between funds held by Synapse’s bank partners and debt owed to depositors. I applied. This discrepancy has sparked a severe crisis, with the bank accounts of tens of thousands of U.S. businesses and consumers frozen.
Gruenberg has since cited the failures of Synapse, Voyager and First Republic Bank as prime examples of the volatility and risk associated with certain deposit contracts, which were not considered intermediaries under the 2020 regulations. are.
Proponents of the pre-2020 standards, like Shayna Olesiuk, director of banking policy at the consumer advocacy group Better Markets, say the 2020 rules create dangerous workarounds and threaten the entire system after the 2023 banking crisis. claims that the level of intermediary deposits rose and allowed all levels to be reached. -A record high of $1.3 trillion in the fourth quarter of 2023.
“The loopholes are unjust and dangerous, increasing the likelihood of liquidity crises, bank failures, and taxpayer bailouts, including those seen in spring 2023,” she noted. “We support further inclusion in the definition of brokered deposits of all types of dangerous ‘hot money’ that could amplify or worsen the crisis, and we support supervisory penalties for banks that rely too heavily on brokered deposits. I support imposing this.”
The FDIC’s 2020 changes to brokered deposit rules also came under intense scrutiny after Silvergate Bank amassed volatile deposits from crypto companies without adequate safeguards. During the collapse of cryptocurrency exchange FTX, Silvergate experienced large withdrawals and sought emergency funds. Critics claim the revised rules have doubled Silvergate’s brokered deposits, worsening its liquidity problems.
Bornfreund said brokered deposits once posed a significant risk, but he believes the proposal could treat certain arrangements as riskier than they actually are.
“Deposit brokers were definitely the real entity that caused the financial crisis of the 1980s, the savings and loan crisis,” he said. “That kind of deposit intermediation is actually relatively rare now, because users can directly find the best interest rates themselves. However, this does not necessarily mean that they are riskier than deposits that users open themselves directly. ”
