What Banking Leaders Need to Know About the FDIC’s Proposed Brokered Deposits Rule

A 2020 change to FDIC rules made partnerships between banks and fintech companies more valuable, as it allowed more deposits to be classified as “core” rather than “brokered.” However, a new FDIC rule proposal could unwind some of this progress.

If enacted, the proposed rule would expand the definition of a brokered deposit, leading more fintech companies to be labeled deposit brokers. For banks, this change could have cascading impacts throughout their portfolio.

Why Do These Proposed Rule Changes Matter?

The FDIC began studying brokered deposits in the 1970s and implemented several rules throughout the following decades to define and regulate this type of funding. The research and regulations aimed to solidify the differentiation between “core” and “brokered” deposits.

Core Vs. Brokered Deposits

Broadly, core deposits come from a bank’s local or target market. These depositors are typically long-term customers who often have other lines of business with the bank. For this reason, these deposits are considered more stable than brokered deposits.

Conversely, brokered deposits are those placed by certain third parties on behalf of customers. These deposits are generally considered less stable because the customers do not have a long-term relationship with the bank and are more likely to move their funds due to market factors.

Examiners evaluate core and brokered deposits when assessing liquidity management programs, assigning ratings, and determining a bank’s assessment amounts. Additionally, banks that are less than well-capitalized are prohibited from accepting brokered deposits in most cases, since they are considered a riskier funding source than core deposits.

2020 Brokered Deposit Rule Updates

In 2020, the FDIC updated Section 29 of the Federal Deposit Insurance Act [FDI Act], which defines which companies are considered deposit brokers and which deposits are considered brokered. The revised definition was part of an effort to modernize regulations to reflect new technologies being used. As such, the definition was narrower and included several exceptions to better identify riskier deposits without penalizing banks for accepting those that are less risky. The end result was fewer deposits were labeled as brokered.

What Would Change Under the Proposed Brokered Deposit Rule?

The new brokered deposit rule, proposed in 2024, would once again change Section 29 of the FDI Act. Unlike the 2020 rule, it would broaden the definition of “deposit brokers” and eliminate or change some popular exceptions.

This new rule would make significant changes to the primary purpose exception, which allows many fintech companies to place deposits at banks without the deposits being considered brokered. It would revise the 25% test so that it only applies to broker-dealers and investment advisors, excluding many fintech companies that currently receive this exception. It would also require that less than 10% of the total assets under management of the qualifying financial institution be placed at banks – rather than the current 25% threshold.

Who Would Be Impacted by the FDIC’s New Rule?

Both banks and depositors could be impacted by the new rule. For banks, some deposits could be reclassified from core to brokered – altering the ratios used to measure their liquidity and resilience. Consequently, affected banks could see their FDIC assessment rates rise.

Additionally, the rule states that only financial institutions will be able to submit certain exemption applications. This change could greatly increase the effort needed to classify deposits correctly. Banks that do not have the capacity to undertake this additional paperwork could lose the benefits of fintech partnerships – like access to deposits outside their geographical area.

Depositors that currently benefit from fintech-bank partnerships could also be impacted by the proposed rule. Many of these depositors enjoy access to extended FDIC insurance as well as competitive interest rates from a wide network of banks. If fewer banks participate in these partnerships due to the proposed rule, depositors could lose those benefits.

Why Did the FDIC Propose the New Rule?

The FDIC has three main goals for the proposed rule change. In summary, they are:

1. Simplify definitions in the 2020 rule.
2. Promote consistent reporting of brokered deposits.
3. Strengthen the banking system.

The first two goals are simple to understand. The FDIC noted some cases where banks have incorrectly labeled deposits as core when they should have been classified as brokered. With simpler, clearer definitions, this would no longer be such an issue. The third goal of strengthening the banking system requires more background information before it can be fully understood.

The 2020 rule resulted in many deposits being re-labeled from brokered to core. In fact, the FDIC reports that brokered deposits declined by $350 billion, or 31.8%, in a 3-month period surrounding the implementation of the rule.¹

The FDIC states that many of the deposits that were reclassified after the rule change still carry the risk of brokered deposits. The proposed rule would result in many of these deposits being reclassified back to brokered deposits to reflect that risk. In turn, institutions that are less than well-capitalized would be prevented from accepting these deposits, and well-capitalized banks would no longer be allowed to consider them core deposits.

Early Comments on The FDIC’s Proposed Brokered Deposit Rule

The FDIC is currently accepting comments on the proposed rule before it is finalized. One of the early comments from a group of companies including the American Bankers Association and American Fintech Council [AFC] requests that the rule be withdrawn. The extensive official comment argues that “the FDIC does not provide sufficient information or time for thorough public consideration of the complex issues raised by the proposal.”

In a press release, AFC Senior Vice President Ian P. Moloney underscored the opinion in the public comment. He wrote:

“In the years since the finalization of the 2020 brokered deposits rule, innovative banks and their fintech partners have developed a wide array of services to help historically underserved communities and improve competition in the broader financial services industry. To undo the prudent reforms made in the [2020] final rule without strong evidence, will undermine the viability of the improved service offerings provided through responsible bank-fintech partnerships.”

Whether these changes are implemented or not depends greatly on the public comment period that is currently underway. Interested banks and fintech companies should work hard to make their voices heard during this time to ensure that both consumers and financial institutions benefit from any rule changes.

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Sources:

¹ Unsafe and Unsound Banking Practices: Brokered Deposits Restrictions, 89 F.R. 68244 (proposed August 23, 2024) (to be codified at 12 CFR Parts 303 and 337). https://www.fdic.gov/system/files/2024-07/fr-npr-on-brokered-deposit-restrictions.pdf

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