Imagining a Post-TAG World Amid Push to Extend It

WASHINGTON — While some community bankers are urging lawmakers to prolong the popular government guarantee for noninterest-bearing deposits, they face the dual task of planning in case those attempts fail.

With the Transaction Account Guarantee still attracting business — funds covered by the program grew 15% in the fourth quarter to $1.4 trillion — its fate is one of the stickiest policy issues post-crisis, sparking discussion of what could replace TAG if it ends as planned on Dec. 31.

Although mimicking the effects of a government guarantee is likely impossible, possible alternatives include private-sector means to keep full insurance for those who demand it, or other liquidity to make up for departing customers.

While many say no option is better than the full coverage that was instituted temporarily in 2008 when the crisis prompted widespread liquidity fears, others counter that pre-crisis funding tools worked just fine and new ones could arise.

"There will likely be someone who steps in with a product or service that bridges the gap," said Anita Newcomb, president of the Maryland consulting firm A.G. Newcomb & Co. "I'm going to bet that what will not occur is that" TAG "goes away and nothing happens."

To keep customers who now expect full coverage, banks could choose one of the services that spread large deposits among multiple banks in increments that each all fall under the standard $250,000 federal insurance limit.

Other options include pledging a slice of a bank's collateral to a large depositor, or pledging collateral through the Federal Home Loan Bank system, so the depositor is fully covered if the bank failed. Alternatively, if an institution fears squeezed liquidity from TAG expiring — and is willing to lose customer relationships that had been built on the program — it could drive up its FHLB advances, or pay higher interest on other deposits or money-market accounts.

"Right now, what makes TAG attractive is we are in a very low-rate environment," said Keith Leggett, senior economist at the American Bankers Association. "If rates start to rise TAG would not be as appealing because savers would be looking for the tradeoff between the unlimited deposit insurance and interest on savings."

A third scenario, observers said, would involve private insurers feeling more confident about the banking industry and either bringing back coverage that existed before the crisis or creating new products.

Michael Heller, president of the ratings firm Veribanc, said the fact that banks had paid fees to the Federal Deposit Insurance Corp. for TAG before last year indicates an appetite for private-sector solutions. (Following passage of the Dodd-Frank Act, which extended the program to the end of this year, the coverage became mandatory and free-of-charge for all banks.)

"If TAG goes away, there will still be motivation by community bankers to try to keep those large deposits from fleeing to larger rivals," said Heller, whose firm underwrote a private coverage product, called Depositsure, in the nineties.

Banks "established a market where they were paying for" TAG "when it was optional," he said. "That leads me to think that … there may be new products or old products that are resurrected."

Many banks may also benefit from increased customer confidence that they have improved in the years since the crisis.

"If a bank can show a Fitch rating or some other indicator that they're in good shape — that their financials are in good order — I don't think they'll have any problem," said Christopher Whalen, senior managing director of Tangent Capital Parnters.

While the industry is essentially split on whether to extend the program, the Independent Community Bankers of America has pled with policymakers to preserve TAG, arguing its expiration will unfairly drive deposit business back to large banks with implied government backing. After the FDIC reported figures Tuesday on participation in the program, an ICBA press release said its popularity "demonstrates the critical importance of extending" it.

Paul Merski, ICBA's chief economist, said if TAG ends banks will "absolutely" do what they can retain the business customers that have used the program. "These are your best small-business customers - your prized accounts that provide you the liquidity to work with those same customers," he said.

But the alternatives have pitfalls, he added. If banks opt for linked deposit products, such as the Certificate of Deposit Account Registry Service run by Promontory Interfinancial Network, Merski said that "is not a private-sector solution.

"It is still FDIC-backed. All they do is take the money and spread it around to many different banks."

Merski said the cost of private deposit insurance, meanwhile, "would be prohibitive because you wouldn't have all of the banks in that system.

"Over the years, even when you had $100,000" as the standard FDIC insurance limit, "there wasn't a huge appetite for the cost of private insurance completely separate from the FDIC fund."

Ronald Paul, chief executive of the $2.8 billion-asset EagleBank in Bethesda, Md., who is a vocal supporter of extending TAG, said his bank is "very focused" on planning for a world without TAG - which includes "accumulating as much as cash as we can and not lending it out."

Paul finds all the alternatives to be unattractive compared to TAG. He said paying higher deposit rates to give customers incentives to stay could lead to higher loan costs for consumers. Meanwhile, raising other types of funds, such as brokered deposits, have regulatory costs.

"We could go out and increase our wholesale borrowings and use that liquidity to make loans. The problem with that is that the regulators frown on wholesale deposits," he said. "But it is nonetheless another alternative."

But others were more optimistic.

Newcomb said while programs such as CDARS typically have certain account restrictions, and may not appeal to those just looking for a safe place from which to make transactions, she said existing services could refine their products for the market of depositors interested only in safety and not returns.

Promontory offers another more liquid product, known as Insured Cash Sweep, which rather than using CDs, as in CDARS, spreads deposit increments around to interest-bearing transaction accounts at multiple banks. Other companies, such as IDC Deposits of Miami, and Anova Financial Corp. in Edenton, N.C., offer similar services using linked accounts at multiple banks.

"I presume that a similar product can easily be spawned" tailored for the customer that most relied on TAG, "assuming the regs are in place that would allow for it, that would simulate what CDARS has done on the retail side," Newcomb said, adding that if a business customer is that reliant on the FDIC coverage, they may be willing to pay for it.

"If a product is spawned that costs the bank, would the business customer view that as a value received and so the bank is able to pass on those costs? It's almost like having private insurance."

A bank could also pursue individual agreements with large depositors, such as municipalities or hospitals. In such cases, the institution would pledge the value of certain assets as collateral to the depositor, meaning the FDIC would then have to cover the customer at 100%. Alternatively, the bank could get the backing of a Federal Home Loan bank through a "letter of credit", which would serve as protection against depositor losses.

Leggett said if a bank decided its real priority following TAG's expiration was holding on to liquidity, rather than client relationships, the institution could focus on higher-rate deposit accounts. "At this point in time, we're watching margins squeezed. But if you start paying higher interest on deposit accounts you may also be able to start charging service fees," he said.

Whalen's advice may seem foreign following a period of such market tumult and government intervention. Still, pointing out the competitive challenges facing other financial sectors, he said banks' best strategy may be just to sit tight.

"I don't think banks are going to need this help, because from a competitive position the problems facing money-market mutual funds are going to give the banks a leg up," Whalen said.

He added that the time has come again for depositors to do own due diligence. "People have to think about this anyway. The government is not going to hold their hand anymore."