On July 30, the FDIC Board of Directors proposed a rule change that could significantly alter how banks classify deposits associated with third-party service providers. These rules would expand the amount of brokered deposits, as well as the number of third-party deposit brokers. The banking industry has had some time to implement and adapt to the 2020 rules, but whether or not this time has been sufficient enough to understand if these rules are working or need to be rolled back is a nuanced question. Moreover, implementing more changes to these policies presents significant challenges to community bankers, who are already facing increased challenges in shoring up deposits, keeping up with assessment fees, and running their institutions.
The 2020 Brokered Deposit Rules
The 2020 brokered deposit rules represented a significant overhaul of the previous regulatory framework. These rules were implemented to simplify the definition of brokered deposits, aiming to strike a balance between maintaining financial stability and allowing banks more flexibility in managing their deposit portfolios.
Key elements of the 2020 rules included a more tailored definition of what constitutes a brokered deposit and an allowance for certain business relationships, such as those with fintech companies, to be excluded from the brokered deposit classification under specific conditions. This was done to reduce unnecessary regulatory burdens on banks, particularly smaller institutions.
The more “lenient” definition of what constitutes a brokered deposit is the key item that is being rolled back in the new proposed rules, which would make almost any BaaS (Banking as a Service) deposit a “brokered deposit.” This is particularly unsettling when you consider the prevalence of BaaS providers, and the fact that nearly 1.3M account holders use BaaS providers.
It is important to note that the effectiveness of the 2020 rules remains uncertain due to the limited time since their implementation. The banking sector, particularly community banks, has not had sufficient time to fully assess whether these changes have yielded the intended benefits. The complexities of the modern financial landscape, combined with ongoing challenges such as the COVID-19 pandemic and economic fluctuations, have made it difficult to gauge the long-term impact of the 2020 rules. As a result, the rush to introduce new rules may be unnecessary, as we don’t yet have enough data on the impact of the 2020 rules.
The New Proposed Rules
The FDIC's proposed rule changes aim to address concerns arising from recent financial disruptions, with the 2023 large bank failures and the collapse of Synapse Financial being cited as primary drivers for this policy shift. These events highlighted vulnerabilities in the banking system, but it’s important to note that brokered deposits aren’t the problem. The 2023 bank failures were a direct result of uninsured deposits, and the responsibility for the collapse of Synapse Financial is a direct result of poor management.
The new rules propose expanding the definition of brokered deposits to include a broader range of third-party relationships, most prominently banking as a service or BaaS deposits. The FDIC argues that a stricter classification of deposits is necessary to mitigate risks and ensure that banks maintain a stable funding base. While it’s important to protect bank safety and soundness, the deposits generated via BaaS applications are primarily consumer deposits, and are generally the opposite of “hot money” or money that moves institutions based on rate.
The Burden on Community Banks
While the FDIC's rationale for the new rules is rooted in safeguarding the financial system, the impact on community banks could be significant. Community banks, which play a crucial role in serving local communities, could face increased regulatory burdens as a result of these changes.
One significant consequence is the potential for higher assessment fees. As more deposits are classified as brokered under the new rules, community banks may see an increase in their risk-based assessment fees. These fees are calculated based on the perceived riskiness of a bank's deposit base, and a higher proportion of brokered deposits could lead to higher costs for community banks.
Moreover, the administrative burden of complying with the new rules could divert resources away from the core mission of community banks: serving their communities. Community banks often operate with limited staff and resources, The added complexity of navigating the new regulatory landscape could strain their operations. Instead of focusing on lending to small businesses, supporting local economic development, and providing personalized customer service, community bankers may find themselves bogged down by regulatory compliance tasks.
While the FDIC's proposed rule changes may be well-intentioned, they risk imposing significant challenges on community banks for little discernible improvement in the safety of our banking system. The banking sector needs a balanced approach that considers the unique role of community banks and allows for a thorough evaluation of existing regulations before introducing new ones.
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