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Notice of Proposed Rulemaking on Brokered Deposits

Chairman Martin J. Gruenberg
 Statement, Board Meeting   Video
July 30, 2024

The FDIC Board is considering today a proposed rule (Proposed Rule) that would revise the FDIC’s regulations to update and clarify provisions related to the definition of a deposit broker.

Section 29 and Brokered Deposit History

Section 29 of the Federal Deposit Insurance Act (FDI Act),1 imposes restrictions on a less than well-capitalized insured depository institution (or banks) from accepting funds obtained, directly or indirectly, by or through any deposit broker for deposit into one or more deposit accounts (referred to as brokered deposits).2 Section 29 also provides that the FDIC may impose, by regulation or order, additional restrictions on the acceptance of brokered deposits as the FDIC may determine to be appropriate.3 

Section 29 is aimed at addressing longstanding concerns regarding brokered deposits. A bank’s use of brokered deposits often raises its risk profile because: (1) such deposits could facilitate a bank’s rapid growth in risky assets without adequate controls; (2) once problems arise, a problem bank could use such deposits to fund additional risky assets to attempt to “grow out” of its problems, a strategy that ultimately increases the losses to the Deposit Insurance Fund (DIF) when the institution fails; and (3) brokered and high-rate deposits are sometimes considered less stable because deposit brokers (on behalf of customers), or the customers themselves, are often drawn to high rates and prone to leave the bank quickly to obtain a better rate or if they become aware of problems at the bank. Historically, and as described in the preamble to the Proposed Rule, various studies and reports have shown that reliance on brokered deposits is associated with a higher probability of a bank’s failure and higher DIF loss rates.4

Recent Experience and the 2020 Brokered Deposit Regulations 

More recent events have also underscored the uncertain nature of third party funding arrangements.  Experience has shown they can be highly unstable, with either the third party or the underlying customers moving funds based on market conditions or other factors. These arrangements can also be prone to other forms of disruption such as the potential or actual insolvency of the third party, as was recently demonstrated by the bankruptcy of Synapse Financial Technologies, Inc. (Synapse).  Synapse, sometimes referred to as a fintech “middleware” company, was a deposit broker that facilitated customer deposits for various fintech companies looking for banking services with insured depository institutions.  The FDIC, the Office of the Comptroller of the Currency, and the Board of Governors of the Federal Reserve System, recently issued a Statement on Third Party Deposit Relationships that reflects supervisory concerns related to arrangements like Synapse.5 The FDIC is also evaluating additional rule-making to address the risks to depositors presented by these types of third party deposit arrangements.

Moreover, the rapid growth of such deposits without corresponding growth in risk management practices can expose banks to operational, liquidity, and legal risks.  A key concern is that some of these funding arrangements are not considered brokered under the current brokered deposit regulations, even though they present the same risks as brokered deposits.

With respect to the current regulations, in December, 2020, the FDIC Board adopted a final rule that established a new framework for analyzing whether certain deposit arrangements qualify as brokered deposits (the 2020 Final Rule).6 Among other things, the 2020 Final Rule narrowed the types of deposit-related activities that are considered brokered and also expanded the types of business relationships that are eligible to be excepted from the “deposit broker” definition. 

Unfortunately, the FDIC’s experiences since the 2020 Final Rule have confirmed some of the risks of this narrower coverage.  For example, the crypto company Voyager was not considered a “deposit broker” -- and therefore deposits it placed in its partner bank were not considered brokered -- merely because it had an exclusive deposit placement arrangement with one bank.  Such exclusive deposit placement arrangements were specifically excluded from the definition of a “deposit broker” under the 2020 Final Rule even though they plainly met the definition of deposit broker. 

As a result, when Voyager failed in 2022, it created the same legal, operational, and liquidity risks for its partner bank as if it had been classified as a deposit broker.  Specifically, Voyager’s partner bank, experienced several risks related to Voyager’s sudden bankruptcy, including, but not limited to: (i) legal risk related to customers’ lack of access to their funds for several weeks; (ii) earnings risk related to legal fees and increases in interest expense as a result of the loss of the low-cost Voyager deposits; and (iii) liquidity risks related the need to replace the Voyager deposits once the bankruptcy court cleared release of the funds to end users.7

The concern here is that less than well-capitalized banks may seek these exclusive deposit placement arrangements as their condition is deteriorating without being subject to the limitations on brokered deposits, even though the risk is the same.

First Republic Bank,8 which failed in May 2023 after contagion effects from the failure of Silicon Valley Bank sparked a significant run on uninsured deposits, is another example of problems with narrowing the coverage of the rule.  This run included a significant outflow of sweep deposits from an affiliate of the bank, and in particular uninsured affiliated sweep deposits.  This case suggests that affiliated sweeps, particularly those that are uninsured, are no more “sticky” than unaffiliated sweeps, contrary to a provision in the 2020 Final Rule that expressly exempts affiliated sweeps from being considered brokered. 

In addition, despite industry outreach by the FDIC, there have been a number of challenges with entities understanding certain provisions of the 2020 Final Rule. 

For example, under the current rule any third party may immediately invoke a primary purpose exception from being considered a “deposit broker” by submitting a notice indicating that it places less than 25 percent of customer assets under administration, for a particular business line, at more than one bank (“25 percent test”).  The FDIC has observed that some banks receiving deposits through a sweep arrangement have incorrectly relied upon a notice submission for the 25 percent test, despite the involvement of an additional third party that meets the “deposit broker” definition.  In some cases, the bank reports the sweep deposits as nonbrokered, relying solely on the presence of the notice submission, without seeking the appropriate documentation to conduct its own due diligence to determine whether the additional third parties involved are deposit brokers.   In turn, this has caused some deposits that meet the “brokered deposit” definition under the 2020 Final Rule to not be correctly reported as brokered on banks’ Consolidated Reports of Condition and Income (Call Reports). 

If left unchanged, this underreporting of brokered deposits could have serious consequences for banks and the DIF.  Such underreporting impedes the ability to evaluate the extent of reliance on brokered deposits and the effects on an bank’s risk profile for supervisory and deposit insurance pricing purposes.  Moreover, the FDIC is concerned that these issues expose banks individually and the banking system more broadly to the type of risk the brokered deposit restrictions are intended to address—namely that a less than well capitalized institution could rely on less stable third party deposits for rapid growth that may weaken the safety and soundness of banks and the banking system and expose the FDIC to increased losses.   

Further, the 2020 Final Rule provides a primary purpose exception for any third party that is “enabling transactions.”  The exception is immediately granted when a third party submits a notice indicating 100 percent of customer funds are placed into transactional accounts and no fees, interest, or other remuneration is provided to the depositor.  The “enabling transactions” test has allowed many third parties to receive a per se primary purpose exception without demonstrating that the primary purpose of the deposit placement arrangement is for a purpose other than providing deposit insurance or a deposit-placement service.  In practice, there is no meaningful difference between a third party’s purpose in placing deposits to “enable transactions” and placing deposits to access a deposit account and deposit insurance. 

Proposed Rule

The changes to the brokered deposit rule contained in this Notice of Proposed Rulemaking (NPR) being considered by the FDIC Board today address the fundamental considerations of the relationship between a bank, a depositor, and a third party intermediary, and the risks the relationship may pose.  The changes would help strengthen the important prudential protections of the brokered deposit rule required by statutory restrictions and reduce the very serious risks that brokered deposits pose to less than well-capitalized banks and the DIF. 

The proposed rule would alleviate many of these concerns by amending the definition of “deposit broker” to, among other things, eliminate the automatic exemption for affiliated sweeps that are using additional third parties, and also cover fee-based arrangements. In addition, concerns would be addressed by eliminating the “exclusive deposit placement arrangement” exception.  It also would eliminate the primary purpose exception for “enabling transactions and would revise the “25 percent test” applicable to any third party to a modified 10 percent test that only applies to broker dealer or investment advisor sweeps. The proposed rule would change the notice and application requirements for the primary purpose exception to apply only to banks, which among other things, would help address the underreporting of brokered deposits.  All of these changes would significantly enhance the protections of the brokered deposit rule. 

In addition, the proposal would reduce operational challenges and reporting burdens on insured depository institutions by simplifying certain definitions, help ensure uniform and consistent reporting of brokered deposits, and strengthen the safety and soundness of the banking system. 

I am pleased to support this proposed rule and its publication for a 60 day comment period. I would like to thank the staff of the FDIC for their thoughtful and diligent work on this rulemaking.

Last Updated: August 12, 2024