The Pendulum Swings Back: FDIC Proposes Changes to Brokered Deposits Restrictions

On July 30, 2024, the Federal Deposit Insurance Corporation (FDIC) proposed revisions to the restrictions on brokered deposits (the “Proposal”). The Proposal is intended to strengthen the restrictions to reflect the FDIC’s experience since earlier revisions in 2020 and the regional bank failures of 2023. This is generally accomplished by undoing key elements of the 2020 revisions and would dramatically expand the number of deposit brokers and the amount of deposits that are brokered.

Below, we provide a background on the brokered deposits restrictions and discuss key elements of the Proposal. The FDIC will accept comments on the Proposal for 60 days after they are published in the Federal Register, which is expected shortly.

Background

Following the 1980s savings and loan crisis, in 1989, Congress enacted Section 29 of the Federal Deposit Insurance Act to impose restrictions on brokered deposits and notification obligations on deposit brokers.¹ The action was based on the regulators’ view that brokered deposits were risky because they potentially drove growth and risk-taking by troubled institutions and were volatile in that they would move based on rates paid by competitor institutions. As a result, beginning in the 1980s, several regulatory initiatives were undertaken to address risks associated with brokered deposits. At the time of these early initiatives, brokered deposits were generally comprised of large certificates of deposit.

To address these concerns, the FDIC issued a regulation under Section 29 that restricts the use of brokered deposits and limits rates paid on interest-bearing deposits that are solicited by banks that are less than “well capitalized” under the Prompt Corrective Action framework.² If an institution is “adequately capitalized,” it must seek a waiver from the FDIC to accept new brokered deposits, and some institutions may be subject to limits on the rate of interest they may pay on brokered deposits. Brokered deposits also are subject to less favorable treatment under the deposit insurance assessment regulation and Liquidity Coverage Ratio requirements.

In 2020, the FDIC finalized revisions to its rules and prior guidance regarding brokered deposits (the “2020 Revisions”). The 2020 Revisions were intended to modernize the FDIC’s framework for regulating brokered deposits, as the deposit-taking capability of institutions had dramatically changed with fintechs and online banking, and they altered both the substantive regulations for brokered deposits and the procedures for requesting exceptions and filing reports. They also modified the restrictions on interest rates for certain types of deposits and clarified the application of the brokered deposit requirements to non-maturity deposits (e.g., deposits without a maturity date).

The 2020 Revisions narrowed the definition of “deposit broker” by more clearly defining the term and creating more exclusions. Under the 2020 Revisions, a deposit broker is defined as:

Any person engaged in the business of placing deposits of third parties with insured depository institutions (“IDIs”);
Any person engaged in the business of facilitating the placement of deposits of third parties with IDIs;
Any person engaged in the business of placing deposits with IDIs for the purpose of selling those deposits or interests in those deposits to third parties; and
An agent or trustee who establishes a deposit account to facilitate a business arrangement with an IDI to use the proceeds of the account to fund a prearranged loan.

The 2020 Revisions added a new process that may be used by any IDI or deposit broker to qualify for the Primary Purpose Exception (“PPE”),³ thus allowing persons who would otherwise be deposit brokers to avoid this classification, and generally limited the filings required for persons relying on many of the designated business arrangement exclusions.

2024 Proposal

The Proposal would change the definition of “deposit broker,” eliminate the “exclusive deposit placement arrangement” exception, and revise the interpretation of the PPE to consider the third party’s intent in placing customer funds at a particular IDI.

Under the Proposal, the definition of deposit broker would be changed by (i) combining the “engaged in the business of placing deposits” (“placing”) and “engaged in the business of facilitating the placement of deposits” (“facilitating”) prongs; (ii) removing the term “matchmaking activities” and replacing it with a deposit allocation provision; and (iii) adding a new factor related to fees. Specifically, the Proposal would provide that a person is engaged in the business of placing or facilitating the placement of deposits of third parties if that person:

Receives third-party funds and deposits those funds at one or more IDIs;
Has legal authority, contractual or otherwise, to close the account or move the third party’s funds to another IDI;
Is involved in negotiating or setting rates, fees, terms, or conditions for the deposit account;
Proposes or determines deposit allocations at one or more IDIs (including through operating or using an algorithm or any other program or technology that is functionally similar); or
Has a relationship or arrangement with an IDI or customer where the IDI, or the customer, pays the person a fee or provides other remuneration in exchange for or related to the placement of deposits.⁴

One of the significant innovations in the 2020 Revisions was narrowing of the definition of deposit broker to include only situations in which a person acts with respect to more than one IDI and has a business relationship with the depositor on whose behalf the deposit is being placed. The Proposal would reverse this change in its entirety.

The PPE was expanded under the 2020 Revisions to exclude a wide range of arrangements from the definition of deposit broker and minimize the administrative process required to rely on the exception. The Proposal would revise the PPE by:

Limiting the exception to situations where the agent or nominee’s primary purpose in placing customer deposits at IDIs is for a substantial purpose other than to provide a deposit-placement service or FDIC deposit insurance with respect to particular business lines;
Allowing only IDIs to file notices and applications to rely on the exception, thereby precluding agents and nominees from directly filing with the FDIC to rely on the exception;
Revising the “25 percent test” designated business arrangement to be available only to SEC-registered broker-dealers and investment advisers⁵ and only if less than 10 percent of the total assets that the broker-dealer or investment adviser has under management (not custody) for its customers are placed at one or more IDIs;
Eliminating the enabling transactions designated business arrangement as an exception;
Requiring additional information to be submitted in connection with applications to recognize new arrangements under the exception; and
Clarifying when an IDI that has lost its agent institution status can regain that status for purposes of the limited exception for reciprocal deposits.

Takeaways

The Proposal is likely to generate significant controversy given that it would reverse many of the provisions adopted in 2020 and require changes to many of the relationships established during the past four years. While the FDIC cites the 2023 regional bank failures, Call Report errors, and overall experience with deposit flows and agent failures as the impetus of the Proposal, these issues should not warrant significant regulatory change after four years. Further, the Proposal is likely to impose a significant burden on IDIs, which now may be less willing to accept deposits, and on fintechs, payment providers, and other agents, which now may be unable to obtain deposit services.

As noted, the Proposal also would subject IDIs to a regulatory “whipsaw” of sorts by requiring them to revisit their contractual arrangements with nominees and agents and invest heavily in monitoring and compliance resources. As highlighted by FDIC Vice Chair Travis Hill in his dissent, the “deposit landscape has become too complex to continually decide which arrangements are brokered and which are not in a fair and risk-sensitive way.” The costs of regulatory change management and compliance program revisions should figure significantly in the industry’s comments on the Proposal.

¹12 U.S.C. § 1831f. The requirement for deposit brokers to notify the FDIC was repealed by Congress in 2000.

² 12 C.F.R. § 337.6.

³ Persons excluded from the definition of deposit broker include those “whose primary purpose is not the placement of funds with depository institutions.”

⁴ The FDIC states that the revised definition is not intended to apply to passive listing services that only advertise information on interest rates offered by IDIs.

⁵The Proposal states that arrangements where a broker-dealer or investment adviser involves a third party would qualify for the PPE only if the FDIC expressly approves of an application from the IDI.