Regulators are keeping tabs on banks that have increased their reliance on wholesale funding.
Wholesale funding, particularly brokered deposits, is a way that banks support loan growth. At the same time, brokered deposits can create risk in an environment of fast-rising interest rates or when there is an abrupt credit crunch.
Community banks have been increasingly turning to brokered deposits in recent months. Such deposits topped $145 billion in the first quarter at banks with assets of less than $10 billion, a 4% increase from a year earlier and the highest total since mid-2011, based on data from the Federal Deposit Insurance Corp.
Banks that use those funds to accelerate dealings in commercial real estate — especially acquisition, development and construction loans — should expect added scrutiny. Regulators have already made it clear that they were monitoring those types of loans as a percentage of a bank’s capital.
“It’s a conceptual discussion that sort of suggests that these more concentrated banks … are starting to exhibit some indicators that, under a stressed set of conditions, they could be more exposed to liquidity issues,” George French, the FDIC’s deputy director of risk management, said during a July 12 advisory committee meeting on community banking.
"Liquidity risk is generally increasing for these institutions,” French said, noting that the FDIC has been taking a closer look at banks where wholesale funding is equal to at least a fifth of total assets.
For now, no one is forecasting an impending liquidity crisis like that one that occurred in 2008. Still, the warning is a good reminder for banks and investors to pay attention to funding sources as interest rates inch up.
Another area to watch is the type of brokered deposits being used. As of March 31, about 91% of those deposits were fully insured, down slightly from 93% a year earlier, based on FDIC data. Also, use of foreign deposits rose by 4.5% in the first quarter from a year earlier.
Banks’ loan-to-deposit ratios could also merit more scrutiny. Community banks had an average ratio of 82.7% as of March 31, which was stable from a year earlier, according to FDIC data.
A spokesman for the Federal Reserve declined to immediately comment. Efforts to reach the Office of the Comptroller of the Currency were unsuccessful.
Issues arise when banks push lenders to make loans but “don’t do a great job of planning for the growth and evaluating the potential risks,” said Ken Proctor, CEO at Cadre, Strategic Risk Management. More lenders need to develop a risk appetite statement that addresses best- and worst-case scenarios, he said.
A number of bankers said they believe they are responsibly managing their balance sheets.
Capital Bank of New Jersey in Vineland, for instance, has always made sure it had the right funding to cover its originations, said Dave Hanrahan, the $472 million-asset institution’s CEO and a member of the FDIC’s community banking advisory committee. The bank’s loan-to-deposit ratio is about 70%.
While regulators have never specifically raised the issue at Capital, Hanrahan said he understands that the FDIC will “be increasing its messaging and its concern to the industry going forward.”
BSB Bancorp in Belmont, Mass., is among the financial institutions with a loan-to-deposit ratio above 100%, meaning it has more loans than deposits on its balance sheet. The $2.3 billion-asset company’s ratio was 126% at March 31.
BSB feels comfortable with how it is managing risk with a high loan-to-deposit ratio, said Bob Mahoney, the company’s president and CEO. BSB, for instance, tries to limit brokered deposits to no more than a tenth of total deposits.
BSB has had “no problem funding” its loan portfolio, Mahoney said, adding that recent loan and deposit growth have been “almost identical.” The banking industry also has an opportunity to bring in more deposits, he said, based on his perspective that more investors are starting to pull funds out of the stock market.
There are other signs that deposits flows could be in flux. Several big banks stated during their second-quarter earnings calls that competition for commercial deposits has increased as clients show more of a willingness to move money around.
The FDIC is also cognizant that the ongoing economic expansion will eventually end, with French warning that the banking industry is already “back in the upswing phase of the cycle.” That will require more vigilance on the part of bankers and their regulators to monitor and mitigate exposures.
“It’s very important to be attuned to strong risk management practices,” French said.
