How Reciprocal Deposits Build Franchise Value

January 16th, 2019

deposits-1-16-19.pngThere are many alternatives to core deposits that banks can utilize to fund loans. Internet listing services, for example, have become popular. Unlike brokered deposits, there are no regulatory deterrents against their use. Still, internet listing-service deposits tend to be more expensive and more price sensitive—hence less stable—than traditional core deposits because they often come from out-of-market customers who chase rates rather than from local customers looking to establish a relationship.

Banks have another important, and arguably better, deposit-gathering tool at their disposal—reciprocal deposits. Thanks to the Economic Growth, Regulatory Relief and Consumer Protection Act, most reciprocal deposits now receive nonbrokered status.

What are reciprocal deposits? These are funds received by a bank through a deposit placement network in return for placing a matching amount of deposits at other network banks. Why would banks exchange equal amounts of money with each other? The mechanics of different reciprocal deposit services vary, but the gist is that a bank that participates in a reciprocal deposit network can offer access to FDIC insurance beyond $250,000 to attract safety-conscious customers who might otherwise consider various alternatives, including:
Depositing large sums into a money-center bank, foregoing some access to FDIC insurance and perhaps relying on ratings agencies, like Standard & Poor’s or Fitch, to help assess bank stability
Requiring that a bank collateralize or otherwise secure a large deposit with Treasuries or other ultra-safe, highly liquid government securities
Manually splitting a large deposit among multiple banks, maintaining relationships with each and negotiating different interest rates, signing multiple agreements and receiving multiple statements

Banks that participate in a reciprocal deposit network like the ability to more effectively pursue these large-dollar deposits from local customers who were previously beyond their reach, or whose collateralization requirements raised tracking and opportunity costs and lowered margins. Banks like that they can take multi-million-dollar deposits and place them through a reciprocal deposit network into other banks participating in the same network in increments below $250,000. The spreading out of the funds into multiple banks makes the entire amount eligible for FDIC insurance. This process enables a customer to access FDIC protection from many banks while working directly with just one. And the originating bank maintains ownership of the customer relationship.

Banks that receive reciprocal deposits from another bank are willing to take those funds because they are doing the same thing with their customers’ money. All told, participating banks exchange funds on a dollar-for-dollar basis so each comes out whole—giving rise to the term reciprocal deposits.

“Reciprocal deposits are popular because they tend to be associated with multi-million-dollar depositors, enabling banks to attract deposits in large chunks with lower acquisition and maintenance costs as costs tend to be spread over much larger deposit amounts,” explains Mark Thompson, president of CenterState Bank in Davenport, Florida. “Moreover, they tend to come from local customers at rates that are more in line with local pricing norms. They also tend to come from customers who are more likely to be interested in a broader, more long-term relationship that may include mortgages, credit cards and other profit-generating services.”

“In stark contrast to listing-service deposits, reciprocal deposits help a bank build franchise value,” according to James Di Misa, executive vice president and chief operating officer of Community Bank of the Chesapeake in Waldorf, Maryland. “Quite simply, reciprocal deposits tend to be large, lower-cost, in-market deposits and, as such, offer greater potential for opportunity and efficiency. For this reason, many banks are replacing at least a portion of their listing-service deposits with reciprocal deposits.”

Banks that don’t want to trade out listing-service deposits entirely can still use reciprocal deposits to augment their usage of listing-service funding. For example, they can use a reciprocal deposit offering to lure more business from a safety-conscious listing-service customer who keeps funds protected at multiple FDIC-insured institutions and who might consolidate some, or all, of their deposits with a bank that can offer access to FDIC protection far beyond $250,000.

And of course, reciprocal deposits can be a good replacement for collateralized deposits and wholesale funding options.

As the competition for deposits heats up, now is a good time for every bank to consider making reciprocal deposits a larger part of its funding strategy.

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Steve Kinner is a senior managing director for sales at Promontory Interfinancial Network.