When Loans Come with Strings Attached: Understanding Deposit Requirements 

In certain circumstances, banks will require depositors to maintain specific deposit levels as a condition for loan approval. While this practice isn’t uncommon it isn't without risks. It's essential for depositors to understand how these requirements work, why they exist, and the potential risks they create.  

What Are Deposit Requirements and Why Do Banks Use Them? 
Deposit requirements are a common requirement in a loan agreement where borrowers must maintain a specified balance in deposit accounts with the lending bank. Banks enforce this practice for several reasons. First, requiring deposits ensures a stable source of liquidity for the bank, strengthening its ability to lend and manage day-to-day operations. Additionally, deposit requirements allow banks to deepen client relationships, providing opportunities to cross-sell other financial products and services. Finally, these requirements can act as a form of risk mitigation, giving the bank a financial buffer within its control if the borrower encounters difficulties. 

While this arrangement aligns with the bank's goals, it can create significant risks for depositors, particularly when required balances exceed deposit insurance limits. 

The Hidden Risks of Deposit Requirements 
One of the most significant risks for depositors is exposure to funds exceeding the $250,000 standard deposit insurance limit, per ownership category, per insured bank. If a depositor must maintain balances above this threshold without additional protection, their funds are at risk in the event of a bank failure. This risk is not just theoretical—consider the recent failure of First National Bank of Lindsay in Oklahoma. 

In an official statement, the FDIC reported that "based on the estimated recoveries of the failed bank assets, the FDIC will make 50 percent of uninsured funds available to those depositors on Monday, October 21, 2024. This amount could increase as the FDIC sells the assets of the failed bank.”  

This means, if a depositor had uninsured funds at that institution, they are only receiving $0.50 on every $1.00 of funds that surpassed deposit insurance limits. This underscores the critical need for depositors to safeguard their assets when faced with such requirements. Beyond this, deposit requirements can restrict financial flexibility, limiting the ability to diversify holdings or capitalize on higher-yield opportunities elsewhere. 

How Depositors Can Mitigate Risks 

1. Diversify Across Institutions: Spread deposits across multiple banks to stay within deposit insurance limits and reduce exposure to any single institution. 

2. Leverage Deposit Protection Tools: Work with a trusted deposit management partner, to enable you to have access to multiple FDIC-insured partner banks, ensuring all deposits remain insured. 

3. Negotiate with Lenders: Work with your bank to explore alternative arrangements, such as providing other forms of collateral instead of maintaining large deposits. 

Conclusion 
Deposit requirements are a standard banking practice designed to serve institutional interests, but they come with potential consequences for depositors. As the failure of First National Bank of Lindsay demonstrates, bank failure risks are real and can lead to significant financial loss. By understanding the risks and taking proactive steps, such as diversifying deposits and leveraging deposit management tools, borrowers can fulfill loan conditions without jeopardizing their financial security. 

Learn how Ampersand can help your organization reduce risk and safely manage your deposits. Contact Ampersand to get started.