FDIC Plan Could Force Banks to Rethink Deposit Strategies

WASHINGTON — A proposed change in the Federal Deposit Insurance Corp.'s small-bank assessment formula may prove a significant factor in influencing funding strategies.

The proposal would replace a current ratio that ups the price for rapidly growing banks holding ample brokered deposits with a ratio that incorporates all core deposits and is applied to a lot more institutions.

The FDIC says the change would benefit most institutions, lowering prices for having traditional funding. But observers say it could further discourage the use of noncore deposits, including those facilitated by deposit brokers and listing services and even make certain reciprocal instruments not subject to the brokered-fund penalty — such as the Certificate of Deposit Account Registry Service — less attractive.

The proposal "could … put more pressure on banks to be less reliant on a listing service and less reliant on CDARS as a solution and have to focus more on traditional retail deposits, or they will have to pass along [higher assessments costs] to the customer," said Joshua Siegel, chief executive officer at StoneCastle Partners.

The new plan, which was unveiled last month and will be out for comment for two months, would apply to institutions with less than $10 billion in assets that are at least five years old.

Under the current scheme, the "adjusted brokered deposit ratio" is only triggered for healthy institutions when at least 10% of a bank's deposits are brokered and its assets have grown at least 40% over the previous four years. But the new core deposit ratio will apply to any institution subject to the small-bank formula. Separately, the proposal includes a new measure that could increase rates for institutions that grow significantly during a one-year period.

While the adjustments would likely help a lot of institutions save on deposit insurance, observers said the broader scope of the proposed core-deposit ratio — compared to the current brokered-deposit ratio — will magnify the significance of funding choices for more institutions.

"The brokered deposit effect will apply more frequently in that it will make its way into the model and make its way into the assessment," said Bimal Patel, a financial services lawyer at O'Melveny & Myers, who recently stepped down as advisor to former FDIC board member Jeremiah Norton.

To be sure, the FDIC proposal aims to be revenue neutral. The agency estimates the plan will lower assessments for most banks while reducing the subsidy stable banks might pay for riskier ones. The FDIC says the change shows a preference for core deposits rather than a bias against brokered deposits, and that a core-deposit ratio has recently been a better test to project losses to the Deposit Insurance Fund. Meanwhile, the adjusted brokered deposit ratio that is currently in place only affected 81 banks as of the end of 2014.

Chris Cole, executive vice president at the Independent Community Bankers of America, said early feedback from members that have tested the new assessment formula seems to confirm that most banks will be paying about the same or less in assessments.

"The tentative results seem to support the overall point of the FDIC that about 90% of the banks are either staying the same or their rates are lowering and the rest of them are seeing higher rates," said Cole.

But observers say the plan could force some institutions to rethink strategies using non-core deposits.

"A bank definitely takes into account the negative connotation that brokered deposits have with regulators," James Kane, co-chair of the financial institutions group at Vedder Price, said. "The feeling of the FDIC is brokered deposits are inherently more risky and a bank that has a lot of brokered deposits is going to have to pay up on assessments."

One particular area the proposal could affect is how institutions weigh the costs and benefits of a product like CDARS. The service — sold by Promontory Interfinancial Network — uses reciprocal deposits and other means to allow banks to offer FDIC backing to depositors who hold more than the insurance limit.

While reciprocal deposits are not typically viewed as core, they were excluded from the definition of brokered when the agency instituted the current ratio in 2009. But some worry the new proposal, which does not appear to treat them as core, could make services like CDARS less appealing.

"The current system rightly recognizes that reciprocal deposits are distinct from traditional brokered deposits" but "the proposed rule … does not make such a distinction, which in our view is unfortunate for community banks trying to compete for large-dollar customers with much larger banks," said Mark Jacobsen, president of Promontory Interfinancial Network. He added that the change would particularly affect community development financial institutions and minority-owned institutions "because they rely on reciprocal deposits to a much greater degree than your typical bank."

Others said the significance of the proposed formula change is amplified as banks emphasize the importance of their funding strategies generally.

"Brokered deposits are coming to the forefront again because funding is strategically becoming much more important," said Donald Musso, president of FinPro, a financial advisory firm.

"The industry's total performing loans have grown for five straight years at a compound rate of 3.3%," Musso said, adding, "There has been a shift from the industry being flush with funding and loan-short following the crisis, to starting to compete for funding."

Yet the impact of the proposal will likely not be known until after the FDIC finalizes the plan. Some noted that institutions to a large extent are still seeking to understand how the agency defines terms such as "core" and "brokered."

Earlier this year, the FDIC released guidance with responses to "frequently asked questions" about what is considered brokered. For example, the document included a whole section on listing services. The guidelines said a service that simply lists deposit rates without placing funds at an institution may not be considered a broker, but funds that are placed by the service are brokered.

"The other question is what is a brokered deposit, and I think that is where there is a lot of complexity," said Patel.