Brokered deposits can be an efficient, inexpensive source of needed liquidity to fund growth, but they do come with regulatory strings attached. Because regulators view brokered deposits as a potentially volatile liquidity source that may lead to overly aggressive growth if not used properly, restrictions are placed on their use.
Never have these restrictions been more evident than during the recent recession, when many banks lost their well-capitalized status and found themselves needing to divest themselves of brokered deposits and limit the amount of interest they offered on their own deposits.
Though the recession has ended, examiners continue to be on the lookout for brokered deposits to ensure they are properly identified and not abused. To assist bankers in identifying what is and is not a brokered deposit, the FDIC recently published “Guidance on Identifying, Accepting, and Reporting Brokered Deposits Frequently Asked Questions” (FIL-2-2015). The FAQs are an amalgamation of formal regulatory requirements, previous interpretive letters and other guidance, and findings of a 2011 FDIC study on brokered deposits.
The FAQs have created controversy because industry critics argue that, in addition to providing a single source for the FDIC’s interpretations on brokered deposit requirements, the FAQs also significantly expand the definition of “deposit broker.” This definition is the crux of the determination of whether a deposit is brokered because a “brokered deposit” is basically any deposit that is obtained from, through or with the help of a deposit broker.
In response to criticism, the FDIC did soften its stance on when parties such as lawyers or accountants will be treated as deposit brokers, clarifying that referrals from such parties will not create brokered deposits if the referrals are not part of a programmatic arrangement involving a written agreement or a fee. It is likely the FDIC’s position will continue to evolve in light of new products, technology and industry concerns. In the meantime, below are a few notable examples of the broad reach of the term “deposit broker” as expressed in the new FAQs:
1. Individuals or entities may be a deposit broker even if they do not place funds in accounts for third parties. The designation of deposit broker applies to individuals or entities engaged in “placing deposits” or “facilitating the placement of deposits” for others. The “facilitation” prong covers a broad range of activities and is generally viewed to include taking actions to connect banks with potential depositors. If a third party takes affirmative steps to steer a potential depositor to a particular financial institution, those actions may qualify as “facilitating the placement of deposits.”
2. Individuals or entities can be a deposit broker even if they are not paid. The “deposit broker” definition does not include a requirement that the broker be compensated. The FDIC points out in the FAQs that whether a third party is paid fees or other direct compensation to place or facilitate placement of deposits is only one factor in determining whether the party is a deposit broker. If a third party is clearly steering potential depositors to a specific financial institution, the third party may be a deposit broker regardless of whether money changes hands.
3. Bank affiliates can be deposit brokers. If an affiliate of a bank, such as an investment company or insurance agency, refers clients to the bank, that affiliate may be considered a deposit broker for facilitating the placement of deposits—even if the affiliate is not paid for the referral. As a related matter, if a bank commonly places funds deposited over the $250,000 FDIC insurance limit with its sister bank, a bank regulator may determine the funds placed at the sister bank are brokered deposits.
4. Dual employees and contractors can be deposit brokers. The brokered deposit regulations include several exceptions to the definition of deposit broker, including employee benefit plan administrators or trustees and trustees of testamentary and irrevocable trusts, among others. One such exception is for an employee of a bank with respect to funds that employee places on deposit with its employer bank. However, in order for this exception to apply, the employee must (A) be employed exclusively by the employer bank, (B) be paid primarily in the form of a salary, (C) not share the compensation with a deposit broker, and (D) use office space exclusively for the benefit of the employer bank. If an employee is shared between the bank and an insurance affiliate or a holding company and that employee places or facilitates the placement of deposits, a regulator could determine the dual employee is a deposit broker, and the funds are brokered deposits.
5. The “primary purpose” exception may require FDIC approval. In cases where none of the other exceptions to the deposit broker definition apply, banks have at times relied on the “primary purpose” catchall exception to determine a particular relationship did not involve brokered deposits. This exception states that an agent or nominee whose primary purpose is not the placement of funds with the depository institution is not a deposit broker. However, in the FAQs, the FDIC states that this exception “applies only infrequently and typically requires a specific request for a determination by the FDIC.” While the regulations do not require FDIC approval in order to rely on this exemption, the expectation is that banks consult with the FDIC before relying on this exemption.
6. Custodial accounts representing prepaid card funds may be brokered deposits. The FAQs indicate that where a third party, such as a retailer, opens custodial accounts on behalf of prepaid card purchasers, the retailers are deposit brokers and the accounts are brokered. According to SNL, this was news to many financial institutions, several of which reclassified their prepaid card account portfolios as brokered deposits for their Q4 Call Reports following the release of the FAQs.
If examiners identify any material misclassifications of deposits as core instead of brokered, the bank may need to amend Call Reports, pay additional FDIC assessments and reconsider its liquidity risk position and contingency plans. Further, if a bank becomes less than well-capitalized, it may need to divest its brokered deposits, so knowing which deposits those are is important. To avoid surprises, banks should be proactive in reviewing whether new and existing sources of deposits may fit the definition of a deposit broker.
Brokered deposits can come from unexpected sources. To avoid surprises, be mindful of the broad, nuanced definition of who constitutes a “deposit broker.”