In a notice of proposed rulemaking (NPRM), the Federal Deposit Insurance Corporation (FDIC) announced its plan to update its brokered deposits regulations.

The proposal will modernize the regulations, which were put in place in 1989, to reflect technological changes and innovations across the banking industry, the agency said.

What happened

In 1989, Congress amended the Federal Deposit Insurance (FDI) Act to add Section 29, which generally prohibits the acceptance of brokered deposits by banks that fail to maintain a minimum level of capital. The law permits the unlimited use of brokered deposit funding for banks that are well capitalized, but cuts banks off from all brokered deposit funding once capital falls below a certain level. In addition, a bank that is not well capitalized generally may not offer deposit rates more than 75 basis points above average national rates for deposits of similar size and maturity.

A “brokered deposit” is generally regarded as any deposit obtained directly or indirectly from or through the mediation or assistance of a deposit broker. Under the FDI Act, a deposit broker is defined as “any person engaged in the business of placing deposits, or facilitating the placement of deposits, of third parties with insured depository institutions or in the business of placing deposits with insured depository institutions for the purpose of selling interests in those deposits to third parties.” The statute provides nine exceptions from the term “deposit broker,” including the “primary purpose exception,” which provides that an agent or nominee whose primary purpose is not the placement of funds with depository institutions is not considered a deposit broker. The FDIC has historically interpreted the term “deposit broker” broadly and the primary purpose exception narrowly.

Since its enactment, the law has struggled to keep up with the changing banking landscape, FDIC Chair Jelena McWilliams explained in recent remarks. “For years, the FDIC faced difficult questions regarding whether different types of deposit arrangements should be reported as brokered,” she said.

The FDIC responded to these questions on a one-off basis, often through nonpublic staff advisory opinions or confidential letters, resulting in a “fragmented, opaque legal regime that exists outside of the FDIC’s public-facing regulations,” she explained.

In 2015 and 2016, the FDIC issued a set of frequently asked questions in an effort to more clearly explain the agency’s interpretation of Section 29 and how it applied to different types of deposits.

The agency followed up with an advance notice of proposed rulemaking (ANPRM) on how to update and modernize the brokered deposit regulations in 2018. After reviewing more than 100 comments, the FDIC released its NPRM with four specific goals in mind, McWilliams said.

First, the proposal “will clarify that various types of existing partnerships in which a consumer maintains a direct relationship with a bank generally would not result in a brokered deposit.” This will encourage innovation within the industry, McWilliams said, “intended to reflect how consumers want to access banking services in 2020 and beyond, not how they did so in 1989.”

For the second goal, the FDIC attempted to track the letter and spirit of Section 29. McWilliams used the primary purpose exception as an example. The statute provides that an entity is not a deposit broker, and thus deposits it places are not brokered deposits, if the entity’s primary purpose is not the placement of deposits at depository institutions.

“Under our proposal, the FDIC would analyze whether the primary purpose exception was met by looking at the business relationship between the third party and the customers for whom it is placing, or facilitating the placement of, deposits, consistent with the plain meaning of the statute,” McWilliams explained.

The third goal focuses on minimizing risk to the Deposit Insurance Fund (DIF), continuing to treat brokered CDs as brokered deposits and considering changes to deposit insurance assessment pricing to address concentrations in funding that are correlated with higher losses to the DIF.

Finally, the FDIC’s new framework aims to “establish an administrative process that emphasizes consistency and efficiency.” The NPRM would create “an easy-to-understand, bright-line standard for determining whether an entity satisfies the statutory definition of a ‘deposit broker’” as well as an application process for implementing the primary purpose exception.

In her remarks, McWilliams also suggested that a more complete overhaul of the brokered deposits statute is warranted, offering two suggestions to Congress.

Section 29 of the FDI Act could be replaced altogether with a simple restriction on asset growth for banks that are in trouble, she said, “a far easier regime for the FDIC to administer, [and which] would at the very least limit the size of the FDIC’s potential exposure and would more directly address the key goal of preventing troubled banks from using insured deposits to try to grow out of their problems.”

Alternatively, Congress could consider repealing the primary purpose exception and replacing it with a more flexible exception based on actual risk to the DIF, McWilliams proposed.

“If Congress chooses to tackle these issues, the FDIC stands ready to provide assistance,” she concluded. “In the meantime, we will implement the law as it exists today.”

To read McWilliam’s remarks, click here.

To read the NPRM, click here.

Why it matters

The FDIC’s NPRM attempts to modernize and update the brokered deposits regulations, in an effort to better reflect today’s banking industry and how consumers interact with banks. In addition, McWilliams proposed broader changes to Section 29 itself in her remarks, making two different suggestions to Congress about how to amend the FDI Act. Changing the landscape for what constitutes brokered deposits may also encourage well-capitalized banks to continue to use alternative deposit-gathering sources, as brokered deposits have historically been regarded as higher risk than core deposits and thus often frowned upon by industry analysts.