Brokered deposit law is woefully outdated

Many businesses across the U.S. have been forced to shutter because of the coronavirus pandemic, yet most people are still able to pay for goods and services and deposit checks uninterrupted.

That’s because banking isn’t something that just happens in a branch anymore. Rather, it happens more often than not over the internet, on mobile phones and through bank partners.

While that seems intrinsic to most people, bank regulations established in the 1980s often treat those deposits gathered outside a branch as brokered deposits. Such a classification comes with enhanced regulatory and supervisory costs because of an antiquated perception of risk, and an outdated legal construct.

Federal Deposit Insurance Corp. Chairman Jelena McWilliams has taken steps to modernize the regulations that define certain deposits as “brokered” because of the involvement of a separate entity or affiliate. But the FDIC is limited by law from fully addressing the problem.

Sen. Jerry Moran, R-Kan., has introduced a solution with the Asset Growth Restriction Act of 2020, which uses a clearer, more efficient and effective approach by replacing the focus on how a bank is funding growth with greater attention on how the bank is growing.

Today, in order to reach customers and build a stable funding base, it is necessary for banks to use a variety of business services, platforms, technologies and other relationships — a trend that has only been accelerated by the pandemic. Some current and future bank customers may never step inside a bank branch again, and bank exclusively online.

However, the regulations classifying certain deposits as “brokered” discourage banks from using these channels that amount to routine business for many commercial enterprises. In fact, the interpretation of “deposit broker” is so broad that it includes virtually any third party involved in gathering a deposit.

Some types of entities that may be inappropriately classified as deposit brokers include: social media platforms running a bank advertisement; or fintech partners that provide software for a bank’s mobile app or have a personal budgeting platform that may also connect customers to accounts that best suit them.

It could also include a bank that has an investment advisor affiliate that provides its customers a streamlined way to quickly and safely transfer funds into an FDIC-insured account, or a health savings account offered by an employer. The list is endless.

The FDIC itself is challenged to keep up with the permutations of how accounts are opened and structured while applying those to a 1989 law, when these types of services didn’t exist.

Another issue with the regulation that misses the mark: often times, brokered deposits are in fact more stable than a branch deposit.

For instance, a brokered certificate of deposit gathered over the internet locks in a deposit for a set period of time and rate. As Congress noted in 1989, and as the FDIC itself has recognized, brokered deposits are not in and of themselves risky.

However, there will continue to be observers that warn of the costly bank failures in the 1980s that led to the creation of the brokered deposit statute. And while they will reflect on a time and a place in banking when the internet didn’t exist, they seem to forget about the massive regulatory changes that have also taken place over the last three decades — changes that not only made the brokered deposit rule irrelevant, but also unnecessary.

Critics’ arguments also don’t factor in the more robust regulatory structure that prevents the abuse of so-called “hot money” deposits that are sold to the highest bidder. When the deposit broker law was written, banks often had near zero and even negative capital levels, which are circumstances that have been addressed by regulator’s prompt corrective actions; enhanced governance expectations like liquidity; interest rate risk identification and management; and the Basel capital framework, among other things.

McWilliams recognized the problem and suggested a solution during a speech last year.

“As the banking landscape has changed, and the permutations of how deposits are structured and offered have expanded, the FDIC's brokered deposits regime has struggled to keep up,” she said Dec. 11 at the Brookings Institution. “A simple limitation on asset growth would also be more durable and should retain its effectiveness as the industry evolves and as banks change the way they attract deposits over time.”

These are welcome comments and should encourage lawmakers to consider Sen. Moran’s legislation, which would provide banks and customers a lasting solution.