Brokered Deposits Rule Threatens to Upend Bank Balance Sheets

Bank executives and boards need to carefully analyze their institution’s liquidity, funding and capital if billions of deposits are deemed risky, following a proposal from the Federal Deposit Insurance Corp. that would undo a four-year-old rule change.

In July, the FDIC proposed changing what deposit arrangements count as brokered, indicating that the agency believes a significant reliance on deposits that come through third-party arrangements increases an institution’s risk profile versus deposits brought by banking customers directly. Some industry observers worry that the rule could have unintended consequences for bank liquidity and capital levels.

“In the worst case, these [newly designated brokered deposits] will have to get offloaded in a way that potentially puts those banks at even greater liquidity risk, especially to the extent that they have a higher concentration,” says Alexandra Steinberg Barrage, a partner at Troutman Pepper and former FDIC staffer.

After the 2020 rule went into effect, it had a drastic impact on the levels of deposits classified as brokered. Unwinding it would presumably do something similar, but in a way that could harm banks, critics say. Banks reported a 31.8% decline in brokered deposits between the first and second quarters of 2021 when the 2020 rule went into effect, totaling $350 billion, according to the FDIC.

The Definition of a Deposit Broker
There is no definition of a brokered deposit, only a deposit broker, which Congress has stipulated the FDIC must define. Historically, the concern was that brokered deposits, usually in the form of brokered CDs, were expensive, weren’t based on deposit relationships and were easy to accumulate. Their concentration at failed banks was correlated to higher costs to the Deposit Insurance Fund, which earned them a stigma among examiners and bank executives. There were a handful of narrow exceptions to the deposit broker designation and the agency addressed most situations on a case-by-case basis, which could be slow at times and potentially contradicting.

The 2020 rule change sought to bring more consistency around the definition of a deposit broker and a set of standards banks could use for their classification purposes, says FDIC Vice Chairman Travis Hill in an interview. Hill worked on the 2020 rule change under previous FDIC Chair Jelena McWilliams and voted against the 2024 proposal.

The Rule Interacting With Reality
Technology has expanded how deposits come into banks, which means under the proposed rule that a large swath of deposits may need to be reclassified as brokered. The historical concern that these are so-called “hot” deposits is “totally divorced” from many of their characteristics, Hill argues.

“What brokered deposits are today is a huge range of things,” he says, pointing out the category includes traditionally brokered CDs that are expensive but stable for their duration, as well as sweeps that can move quickly or contractual fintech partnerships that would be difficult for either party to prematurely unwind. “We have this overarching term, but it now includes different things that present totally different types of risks.”

According to a staff memo regarding the new rule, however, the prior rule “allowed for a significant number of business lines to be excluded from the deposit broker definition … even though such deposits present the same or similar risks as brokered deposits.”

“More recent events have also underscored the uncertain nature of third party funding arrangements,” said FDIC Chairman Martin Gruenberg during the July meeting before voting in favor of the rule. “Experience has shown they can be highly unstable, with either the third party or the underlying customers moving funds based on market conditions or other factors. The rapid growth of such deposits without corresponding growth in risk management practices can expose banks to operational, liquidity and legal risks.”

The new rule would narrow that definition by undoing exemptions created under the 2020 rule change. This would impact bank-affiliated sweeps that use additional third parties and popular banking as a service arrangements that include exclusive deposit placements and transaction enablement. The rule was approved in a 3-2 vote by the FDIC’s board and is now open for comments.

The brokered classification could force banks to pay closer attention to the risks these arrangements present — both the regulatory and legislative consequences, as well as other risks, like their legal and operational complexity. Even if some deposits are reclassified as brokered, they may not behave the same way other brokered deposits behave — complicating the liquidity analysis and risk assessment that bank executives and examiners conduct.

“More attention to the riskiness of all kinds of deposits is a good thing and mitigation of that risk, from a bank perspective, is a positive thing,” says Steinberg Barrage. “But only having brokered versus non-brokered [does not get] that nuanced result that you ought to be getting, based on how banks think about each of these arrangements.”

At the minimum, banks that end up with more brokered deposits would pay more in deposit insurance assessments, potentially challenging the economics of some of these arrangements. Some banks may want to revisit the structure of these arrangements, to see if they could be structured to qualify as not-brokered under the narrower exceptions.

Well-capitalized banks can use brokered deposits without restriction, although Hill observed there can be “a reflexive judgment by examiners that the deposit is ‘risky,’” according to a July speech he gave in advance of the board meeting. Adequately capitalized banks must receive a waiver from the FDIC to accept brokered deposits and undercapitalized banks are prohibited from accepting them. This can create a deposit runoff situation that challenges a bank’s liquidity and could contribute to closure.

“What I worry about if [the rule] gets completely overhauled is a world where banks are like ‘I’m not going to touch brokered deposits. It’s not worth it for me anymore,’” Steinberg Barrage says.

The proposed rule comes at the same time as the FDIC is gathering information about how deposits behave. At the same FDIC board meeting, the agency issued a request for information on uninsured deposits at banks, just a week after it joined prudential regulators in another request for information on bank-fintech partnerships. The uninsured deposit run that led to the failure of Silicon Valley Bank in March 2023 underpins that a core deposit program can have severe and fatal risk characteristics that executive teams must also manage.

“The fact that a core deposit program takes time … doesn’t necessarily mean that’s going to create a less risky bank per se,” says Jason Cave, principal at Piedmont Risk Advisors and former FDIC staffer. “But it’s easier for regulators to say, ‘Fast growth is bad.’”

Operationally, Steinberg Barrage says bank boards and executives should examine the rule against their banks’ deposit arrangements to identify what funds may need to be reclassified as brokered against total deposits and total liquidity, to better understand the liquidity, reporting and capital implications of the rule. She also suggests that banks communicate these figures to their examiners. Finally, she recommends banks revisit their risk assessment and appetite in light of their potential brokered deposit concentration and conduct a scenario analysis and liquidity stress test to explore what could happen if these newly brokered deposits needed to roll off the balance sheet.

Steinberg Barrage encourages community banks to submit comments to the FDIC and consider participating in the two outstanding requests for information.