ABA's Letter to FDIC on Brokered Deposits

Robert E. Feldman
Executive Secretary
Federal Deposit Insurance Corporation
550 17th Street, N.W.
Washington, D.C. 20429

Dear Mr. Feldman,

The American Bankers Association (ABA) appreciates the opportunity to comment on the Federal Deposit Insurance Corporation’s (FDIC) advance notice of proposed rulemaking (ANPR) on brokered deposits. ABA is supportive of the comprehensive review and agrees with the FDIC that significant changes in technology, business models, and products warrant a review of the regulations, interpretations, guidance and other policies that make up the FDIC’s approach to brokered deposits. The current overly broad interpretation and application of who is considered a deposit broker, and by extension what deposits are considered brokered, is impeding bank innovation, harming consumers, unnecessarily stigmatizing key funding sources and thus inhibiting bank efforts to innovate and maintain a diversity of funding.

Enacted in 1989, as part of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), Section 29 of the Federal Deposit Insurance Act (FDIA) sets restrictions on the acceptance of brokered deposits by institutions with weakened capital positions. The statute was intended by Congress to prevent troubled institutions from holding funds placed by third-parties whose primary business is “placing deposits or facilitating the placement of deposits of third parties” with insured depository institutions. FDIC interpretations (in the form of staff advisory opinions, frequently asked questions and other guidance) over the last 30 years have gone well beyond the statutory intent by extensively expanding who is considered a deposit broker, narrowly interpreting the exceptions, and applying restrictions beyond the focus of Congress on troubled institutions. Some types of entities that may currently be inappropriately classified as deposit brokers include, among others, —

• Social media platforms
• Fintech partners, such as apps/application programming interfaces(APIs)
• Bank affiliates and subsidiaries, including operating subsidiaries
• Employees of bank affiliates and subsidiaries
• Homeowners associations
• Advertising and marketing partners
• Websites for personal finance organization, advice, and improvement
• Alumni associations and other member-based organizations
• Universities
• Small businesses.

Compounding the detrimental effect of a broad interpretation of “deposit broker” is an inapt supervisory use of brokered deposits and the national rate cap as a gauge of volatile or high-risk funding. Currently, there is a significant overlap between the FDIC’s labeling of deposits as “brokered” and what, for liquidity and interest rate risk management purposes, has historically been considered “core” funding. As a practical matter, the FDIC has failed to recognize that the two categorizations are no longer mutually exclusive, leading to supervisory and regulatory bias against what, in actual practice, are stable, relationship deposits.

A fundamental role of banks is to provide financial services including deposit taking, lending, access to the payment system, wealth management, trust and custody services and cash management services. Modern technology, including an increasing diversity of financial affiliations, and the creation of and growth in online and mobile banking, allows banks to offer these services, gather stable deposits and obtain access to potential depositors via new mechanisms. Going forward, it is imperative that the FDIC improve and modernize its framework to focus on the original purpose of Section 29 and ensure that banks are not penalized for engaging in practices that are well within the bounds of a bank’s normal course of business, including responding to evolving customer preferences and enhancing diversification and resilience in bank funding.

A clearer, more modern approach would embrace the use of modern products and deposit gathering mechanisms that allow banks to leverage innovation and provide consumers with more flexibility, convenience, and transparency. To achieve this, we recommend that, consistent with Congressional intent, the FDIC significantly narrow who is considered a “deposit broker” based on clearly articulated policy goals. A good starting point, consistent with the meaning of the statute, would be to limit the classification of an entity as a “deposit broker” to persons that contract to place deposits of unaffiliated third parties. Such a clear definition would decrease uncertainty and distinguish third parties involved in the provision of banking services from those acting as a broker of deposits. Further, consistent with Congress’ intent, the restrictions on gathering and holding brokered deposits should be limited to troubled depository institutions.

Of equal importance is a recognition that certain deposits, such as those where the bank and the customer have a direct relationship, are by definition, not “brokered.” Relationship deposits would include those generated from operating and other subsidiaries and affiliates of a bank, and other deposits involving a direct, continuing relationship between a customer and an insured depository institution. Empirical evidence suggests that these deposits are among the most stable,; because the FDIC’s current interpretation of “deposit broker” hinges on the involvement of any third party, many deposits scoped into current interpretations are actually among the most stable funding sources. Penalizing these deposits is harmful both to banks and their customers.

Further, the methodology behind the national rate cap is in need of revision. Many examiners inappropriately use the national rate cap (which Section 29 directs the FDIC to establish) as a proxy for high rate deposits at well capitalized institutions. The rate, however, does not reflect a market rate consistently across all stages of the economic cycle and is not dynamic enough to adapt to changes in competition or other drivers of deposit market conditions. Establishing a more robust and relevant rate will go a long way to ensuring that healthy, well-capitalized banks are not inappropriately discouraged from holding stable funding gathered at rates consistent with the markets in which they operate.

As the FDIC engages in a comprehensive review of its regulations and policies regarding brokered deposits, we urge the agency to consider the policy goals it seeks to achieve and the alignment of those goals with both Section 29 and modern banking practices. Again, we remind the FDIC that well-capitalized banks should not be subject to general supervisory limitations regarding the amount of brokered deposits they can accept or the deposit rates they may offer.Neither should the application of “brokered deposits” be so broad that the industry is required to perform costly stress tests to manage a potential funding cliff that the FDIC itself has created, by expansive application of its overly broad characterization of brokered deposits. We remind the FDIC, as Congress noted in 1989 and as the FDIC itself has recognized in the ANPR, that brokered deposits are not in and of themselves risky. This has become particularly true given the significant changes in funding markets and various other prudential supervision tools put in place since the early 1980s.

The purpose of this letter is to highlight key problems with the current framework for and application of the FDIC’s brokered deposit interpretations and offer suggestions as to how it can be modernized and better aligned with the goals Congress had in mind when enacting Section 29. Below, we first recount the objective of Section 29, then describe the ways in which FDIC’s interpretations of Section 29 have been overbroad, then explain how, by focusing its characterizations of deposit broker and excluding relationship deposits, FDIC can modernize its approach to Section 29.

We also refer the FDIC to the letter submitted by ABA’s HSA Council, for technical discussion about those products and how they intersect with the brokered deposit framework.

Congress enacted Section 29 to stop abuse of brokered funds by weak and troubled institutions

Section 29 was adopted by Congress in connection with the savings and loan crisis of the 1980s. At that time, many savings and loans relied on funding in the form of certificates of deposit (CDs) bundled for investors by third parties, which became known as brokered deposits.Brokered deposits were then new products, considered unstable and highly rate sensitive. Typically, they were bundled and sold in bulk to the highest bidder. Ultimately, institutions that depended on this type of funding were more expensive for the federal deposit insurance agencies to resolve in the event of failure.

Section 29 was intended to make resolution of failed banks less costly by restricting weak institutions from holding brokered deposits. Initially, the FDIC sought to regulate brokered deposits by limiting the deposit insurance available for such deposits. Its 1984 proposed definition was, however, rejected by a court on the grounds that it exceeded FDIC’s authority. When Congress took up the idea of limiting brokered deposits, it started with therejected definition, but significantly narrowed its scope of application. Despite the rejection of the FDIC’s initially proposed definition by both the courts and Congress, FDIC continues to reflect it in its implementation of Section 29.

The attached legal memorandum from Jones Day provides an analysis of the legislative history of Section 29, including the regulatory initiatives of the FDIC that preceded its adoption. The memo provides insight to Congressional intent and policy goals, as well as affirms that the FDIC has ample authority to make appropriate changes to its body of interpretation and guidance.

The definition of “deposit broker” has expanded well beyond its original purpose, with little justification

With Section 29, Congress took a targeted approach, intending to prevent weaker institutions from accumulating expensive, enhanced risk funding that provides little franchise value to the bank accepting the funds. Today, however, the term “brokered deposits” permeates banking regulation and supervision, yet the current framework, and process for designation of an entity as a deposit broker, is ad hoc, and lacks cohesion, public input and transparent policy goals. The result is an expansive definition of “deposit broker” that captures funding and institutions beyond what was targeted under Section 29.

FDIC staff has interpreted two key elements of the statutory definition of deposit broker in issuing its many, expansive, interpretations since Section 29 was adopted: “any person engaged in the business of placing deposits, or facilitating the placement of deposits, of third parties with insured depository institutions” [emphasis added]. The FDIC staff’s interpretations accordingly hinge on the presence of a third party, however peripherally involved. In contrast to the deposit placement practices that generated concern in the 1980s, the FDIC’s current brokered deposit classification extends broadly to deposits acquired with the involvement of any unaffiliated party–despite the fact that this is not what Congress intended. For example, under existing interpretative guidance, a deposit broker may be found to include (among others)—

• Social media platforms
• Fintech partners, such as apps/application programming interfaces (APIs)
• Bank affiliates and subsidiaries, including operating subsidiaries
• Employees of bank affiliates andsubsidiaries
• Homeowners associations
• Advertising and marketing partners
• Websites for personal finance organization, advice, and improvement
• Alumni associations
• Universities
• Small businesses.

As noted in the ANPR, the FDIC looks to certain criteria to determine whether a person or entity is engaged in placing deposits or facilitating the placement of deposits to determine if that person or entity is a “deposit broker.” FDIC staff reviews such arrangements on a case-by case basis, considering the following factors:

• Whether the third party receives fees from the insured depository institution that are based (in whole or in part) on the amount of deposits or the number of deposit accounts;
• Whether the fees can be justified as compensation for administrative services (such as recordkeeping) or other work performed by the third party for the insured depository institution (as opposed to compensation for bringing deposits to the insured depository institution);
• Whether the third party’s deposit placement activities, if any, are directed at the general public as opposed to being directed at members (or “affinity groups”)or clients;
• Whether there is a formal or contractual agreement between the insured depository institution and the third party (e.g., referring or marketing entity) to place or steer deposits to certain insured depository institutions;
• Whether the third party is given access to the depositor’s account, or will continue to be involved in the relationship between the depositor and the insured depository institution.

It is unclear how these criteria were derived, on what legal basis, how they are used, and which factors, if any, are drivers of a “deposit broker” designation, since none of them were exposed to public review and comment. What is clear is that the criteria are so broad as to describe features of virtually any third party arrangement, however incidentally linked to a deposit account.Moreover, the parameters do not reflect changes in technology and business structures that are responsive to customer preferences for user simplicity and transparency or new business models. For example, some banks now employ (in whole or in part) a “branchless banking” model whereby depositors are able to establish and manage accounts without having to enter a physical retail branch, increasing access to banking services generally. There is little evidence that suggests these funds, or business models, pose enhanced risk to either banks or the deposit insurance fund.

The wide net cast by the FDIC unnecessarily increases the costs and regulatory consequences associated with holding deposits labeled by the FDIC as brokered. Over the past 30 years, there have been numerous changes to the capital, liquidity, and resolution regulations, most recently through the Dodd-Frank Act and the implementation of Basel III standards. Many of these rules, such as the liquidity coverage ratio, and supervisory exercises such as those related to capital stress testing, incorporate the FDIC’s definition of brokered deposits, employing the presumption that deposits designated as brokered are a significantly less stable source of funding than other types of deposits. FDIC deposit insurance assessments incorporatehigher costs for deposits that are considered brokered. Accordingly, it is now of even greater importance that FDIC’s characterization of deposits as brokered accurately reflect the narrow scope contemplated by Section 29.

Customers want the convenient services inhibited by FDIC brokered deposit designations

Given the technological changes that have taken place since the early 1980s, the FDIC’s overbroad interpretative framework hinders banks from leveraging innovations that make accessing and managing their financial assets more efficient for customers. Today’s banking customers are increasingly looking at the suite of products and services offered, convenient access to their funds, and services such as direct deposit and bill pay or investment management. In the modern marketplace for bank deposits, factors other than interest rate, such as brand awareness/loyalty, customer service, ease of access, mobile applications, digital wallets, etc., are often the mostcritical factor for acquiring and retaining customers.

Focus the interpretation of “deposit broker” and exclude relationship deposits

In order to ensure that neither banks nor their customers are disadvantaged by an overly broad classification of deposits as brokered, we urge the FDIC to limit the classification of an entity as a “deposit broker” to persons that contract to place deposits of unaffiliated third parties with banks or who contract with troubled insured depository institutions for the purpose of selling interests in their deposits to third parties.

Additionally, deposits involving a direct, continuing relationship between a customer and an insured depository institution should be expressly excluded from consideration as “brokered,” even if an unaffiliated third-party is involved in the origination of the deposit or maintains an ongoing relationship with the depositor independent of the deposit relationship. There is scant evidence that the relationship deposits gathered through the normal course of providing banking services through affiliates or marketing partners pose enhanced risk to safety and soundness or the deposit insurance fund. On the contrary, the FDIC, together with the other banking regulators, has recognized retail relationship deposits as among the most stable sources of funding through classifications made in rulemakings such as the liquidity coverage ratio and the net stable funding ratio. Yet, extant FDIC guidance has also caused many such retaildeposits to be classified as “brokered” simply because there is a third party indirectly involved or involved only in sourcing the customer relationship with no ongoing involvement with respect to the deposits. Some examples of deposits where the banking organization and the customer have a direct, ongoing relationship are discussed below.

• Affiliate and Subsidiary Funds. Since 1989, there have been many regulatory and statutory changes, including the Gramm-Leach-Bliley Act, which allowed for the affiliation of banks and securities firms. Additionally, technological developments have significantly increased customers’ ability to access their accounts more efficiently. Together, these developments have significantly altered the way customers engage with their financial institutions and allowed new products to develop that meet customers’ demand to have a seamless relationship with their banking organization.

  • Sweep accounts. One product that has emerged since Section 29 was enacted is sweep deposits. While the FDIC excludes a portion of these deposits from classification as brokered, it imposes arbitrary limitations in order for them to be exempt under the primary purpose exemption. In 2005, the FDIC’s General Counsel issued a staff opinion stating that, “when certain conditions are observed, the primary purpose of a broker dealer in sweeping customer funds into deposit accounts at its affiliated IDI is to facilitate customers’ purchase and sale of securities.”

    Among the conditions is that funds are not swept to a time deposit account and do not exceed 10 percent of the total assets handled by the affiliated broker dealer.Since the broker dealer has little or no control over how much cash customers choose to keep in their brokerage accounts (and that proportion of cash can significantly increase during market downturns and customers’ resulting flights to safety), the broker dealer is unable to do anything to ensure that it remains in compliance with this condition—except perhaps by moving customer cash into other products such as money market funds. The insured depository institution is permitted to pay fees to the affiliated broker dealer, but the fees must be flat fees (i.e., per account or per customer fees) representing payment for recordkeeping or administrative services and not for the placement of deposits.

    Sweep deposits received by banks from affiliated brokers are demonstrably stable. Indeed, during the financial crisis data show that banks saw a net inflow of sweep deposits from brokerage customers as they de-risked by selling securities holdings. This counter-cyclical effect increased, rather than decreased, stability for these banks in a time of uncertainty. The FDIC has acknowledged in both its 2013 Study on Core and Brokered Deposits and the Liquidity Coverage Ratio regulations that deposits received by a bank through an affiliated broker’s sweep program are more stable than various other types of deposits at banks. These deposits from affiliates of the bank should not be classified as“brokered.”

  • Referrals. Many customers of a broker-dealer or other affiliate of a bank may want banking-specific services such as a home mortgage or a savings account. There is no regulatory penalty to the bank (in terms of funding costs) for an employee of the broker-dealer to refer the customer to its affiliated banks for a mortgage, car loan, or credit card. However, it is likely that an employee referral for a checking or savings account would cause those deposits to be considered brokered, which not only impacts the bank’s funding costs, but also the customer experience, leading to potential confusion for a customer seeking a consistent experience across their financial products. Such referrals should not be deemed as creating “brokered deposits.”

  • Deposits Gathered from Operating Subsidiaries. For purposes of efficiency, and other reasons, some banking organizations create operating subsidiaries. These deposits do not have share the characteristics of those intended to be restricted by Section 29. Operating subsidiaries are under the exclusive control of the parent insured depository institution (IDI), engage only in activities permissible for an IDI and are treated as a division of the IDI for purposes of most supervision and regulation. Because the activities of operating subsidiaries, including generating deposits for a parent IDI, are activities in which the IDI could engage directly, deposits placed by operating subsidiaries (and their employees) with the parent IDI are essentially deposits generated by the parent IDI itself. The choice of corporate structure, which may provide operational and other benefits, should not be penalized under the FDIC’s interpretation of brokered deposits. FDIC should revise its regulations to clarify that operating subsidiaries of an IDI are not deposit brokers with respect to deposits placed with the parent IDI.

• University Products. Universities and colleges may enter into an agreement with a bank for the bank to be the provider of banking services to students, faculty, and staff (collectively “University Patrons”), who have the option to access the bank’s products and services. These agreements typically are long-term arrangements that provide the bank with the right to market its products and services to University Patrons in exchange for some fee paid by the bank to the university. The university is not in any way involved in opening or maintaining a bank account for a University Patron. The deposit accounts opened through these programs do not behave like traditional brokered deposits: the accounts often represent long-term banking relationships that can extend well beyond a student’s graduation.

  One service often offered under the agreement is a campus ID card that has payment functionality through a co-branded debit card. These arrangements offer University Patrons the convenience of carrying a single card for campus identification and banking access while offering additional benefits, such as waivers of certain bank fees for accounts linked to campus cards. The cards are optional, and University Patrons may select a campus ID card without payment functionality. The university is not in any way involved with opening or maintaining the bank account, which is handled exclusively between the bank and University Patron who chooses the debit card option. FDIC has improperly classified these deposits as “brokered,” despite bearing no similarities to deposits intended to be covered by Section 29 of FIRREA. The deposit accounts underlying the campus ID cards with payment functionality should not be considered brokered deposits.

• Health Savings Accounts (HSAs). As with sweep accounts, HSAs are a new products, created since the enactment of FIRREA. HSAs are an important and growing part of employee benefit strategies and are the only health benefit product in the United States that is portable. They were specifically designed so that employees who move from jobto job can associate their HSA with their new employer’s HSA-qualifying health plan. This is possible because HSAs are owned by individuals, in all cases, not employers or any other third party. There are no exceptions. By definition, HSAs involve longer-term relationships with banks, much like individual retirement accounts, and should not be characterized as “brokered deposits.

Firms that provide normal course marketing arrangements and practices should not be considered deposit brokers

Many businesses engage in marketing and advertising to promote their products and attract customers, including digital marketing channels such as social media and other, non-traditional forms of advertising. Banks, like other businesses, need to advertise and market their products and services, through modern channels. However, the current FDIC interpretative guidance, which largely dates back to letters published in the late 1980s and early 1990s, focuses on marketing techniques favored at the time, such as TV and direct mail, and fees earned as key factors informing whether or not a third party is “facilitating the placement of deposits.” Additionally, these letters focus on whether a third party is engaged in “active marketing,” and in particular whether such third party is engaged in activity that is more than “passive and indirect.”

FDIC interpretations have taken an unnecessarily broad view of what constitutes “facilitation” in the context of marketing, finding that mere receipt of a volume-based marketing fee by a third-party would make the third-party a deposit broker. There is little evidence that deposits gathered through marketing practices widely employed by businesses today pose enhanced risk to either individual banks or the deposit insurance fund. Given the wide use of these marketing arrangements by a plethora of U.S. corporations, it is hard to understand how the FDIC interprets them as facilitating the placement of deposits for banks. The hiring of a marketing firm, or placing a banner on a popular search engine to advertise its products and attract customers, does not make the marketer or the search engine a “deposit broker” just because it is a bank that has hired the marketer or contracted with the search engine. Moreover, there are no equivalent restrictions on marketing of loans, other assets, or liabilities as there are for deposits, which puts deposit gathering at a disadvantage and can be confusing for customers looking for seamless and consistent interactions with their banks across products. Should an improper or abusive practice arise, it can and should be addressed through appropriate supervisory action.

Regardless of the fee structure, marketing and referral arrangements with third parties should be excluded from brokered deposit considerations, when the customers engage directly with the bank. Active production and distribution of marketing materials does not adversely affect the stability of the funds gathered, nor does the structure of fees paid to the advertising platform. For example, common digital marketing relationships utilize a “cost per click” or “cost per acquisition” compensation model; however, the fee structure has no bearing on the stability of the resultant account relationship.

Additionally, third parties offering prepaid products tied to deposit accounts at a financial institution are not “deposit brokers” simply because they market an alternative to a traditional deposit account. Designation of deposits associated with prepaid products as brokered inappropriately inhibits innovation by financial institutions in this space and by extension impedes banks’ ability to provide these customers with the most up to date options. These accounts should not be labeled as “brokered deposits.”

The national rate cap should be above the market rate for deposits

In addition to setting restrictions on brokered deposits, Section 29 directs the FDIC to calculate a national rate cap on the interest rates weaker institutions may offer on deposits. The cap is established by adding 75 basis points to the “national rate.” The national rate is currently established by taking a “simple average of rates paid by all insured depository institutions and branches for which data are available”. Because banks with the most branches drive the calculation of the average rate, the current rate does not accuratelyreflect the cost of deposits for community banks, and others, that do not have extensive branch networks. As a result, the FDIC’s rate can be (and currently is) significantly below market in a rising rate environment.

The rates that banks choose to offer on deposits are determined by reference to a variety of factors across multiple tenors and products, including their competitors’ rates, and various benchmarks including Treasury rates, Federal Home Loan Bank (FHLB) advances, swap rates, and money market rates, among others. However, the FDIC’s methodology does not currently employ or consider these common benchmarks or indexes to set the national rate cap.

An artificially low rate is problematic for well-capitalized and weaker banks alike. Because examiners use the national rate cap as a proxy for higher risk deposits, even well capitalized banks are often discouraged from raising or holding deposits with a rate higher than the national rate cap. For weaker institutions, a non-competitive rate means that these banks have a reduced ability to improve their condition, as they are impaired in their ability to raise funds to sustain their assets. Moreover, it is unclear how the 75 basis point add-on was derived, whether it allows for a sufficiently high level result during all phases of interest rate and business cycles, or if it should be dynamic though the cycles.

In order to identify outlier interest rates, as directed by the statute, we recommend that the FDIC investigate the use of robust, transparent, and widely used benchmarks to determine a market interest rate, with an appropriate and dynamic add-on to establish a threshold for rates that are tolerably above market. For example, as a base rate the FDIC could use the top ten rates posted on bankrate.com, a median of FHLB advance rates or a composite rate of widely understood and accessible benchmarks, or a combination thereof. The add-on to the base rate should be dynamic to ensure the FDIC’s national rate is well above that of the deposit market rate. ABA recognizes the difficulty of creating a rate that remains robust through all stages of the economic and interest rate cycles. We recommend that the FDIC allow banks to use their local FHLB advance rate, plus the FDIC’s add-on, as an alternative to the national rates. The FHLB rates are a dynamic reflection of the regional market cost of funds and would likely be an accurate gauge of the market through the cycle. An accurate FDIC rate, with add-on, should land sufficiently above normal market rates so as to identify only outlier deposit pricing, including ‘specials’ or deposit products with features that may not fit into the FDIC’s categories for purposes of the national rate cap.

Conclusion

We appreciate the FDIC issuing the ANPR as an important step toward modernization of the brokered deposits rules and policies. We encourage the FDIC to reform its policies and programs regarding brokered deposits using the variety of tools at its disposal. We note that while changes in the statute might be considered, the problems that we have identified in this letter were created by regulation, guidance, regulatory interpretations, and agency policy, all of which can be refined and reformed in similar ways. These policies evolved through various iterations, and it may take a series of actions to conform brokered deposit policies more closely with the purposes of the statute and the realities of banking and customer relationships today. We stand ready to continue this important dialog with the FDIC for the benefit of our customers and to reinforce the strength of the banking system, including through embracing the diversification of funding sources that modern business models and technology make possible.

If you have any questions about these comments, please contact the undersigned at (202) 663-5182 or email: [email protected].

Sincerely,
Alison Touhey
Vice President & Senior Regulatory Advisor

Attachments

Download the letter to read full attachments.

• Memo re: Acceptance of Brokered Deposits, February 25, 2019