On July 30, 2024, the Federal Deposit Insurance Corporation
(FDIC) issued a notice of proposed rulemaking (NPRM) that
would amend the regulatory framework used to determine whether
deposits qualify as "brokered deposits" under Section
337.6 of the FDIC's regulations. Among other things, the
proposed amendments (Amendments), which if adopted would represent
the second substantial revision of the FDIC's brokered deposits
regulation in recent years, would revise the "deposit
broker" definition, expand the types of deposit-related
activities that are considered brokering, and amend the application
and notice processes for insured depository institutions
(IDIs).
This Advisory discusses recent developments and the FDIC's
stated justification for its proposal, outlines the key provisions
of the Amendments, and highlights notable takeaways for financial
institutions and deposit service providers.
Background
Section 29 of the Federal Deposit Insurance Act (FDIA) restricts a less than well-capitalized IDI from accepting, directly or indirectly, brokered deposits.1 Although Section 29 of the FDIA does not directly define "brokered deposits," the FDIC has defined the term as "any deposit that is obtained, directly or indirectly, from or through the mediation or assistance of a deposit broker."2 Thus, the meaning of "brokered deposit" turns upon the definition of "deposit broker."
More broadly, the FDIC defines a "deposit broker" as (1) any person engaged in the business of placing deposits of third parties with IDIs; (2) any person engaged in the business of facilitating the placement of deposits of third parties with IDIs; (3) 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 (4) 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.3
The FDIC's proposed Amendments would effectively reverse a 2020 final rule adopted under former Chairman Jelena McWilliams that narrowed the definition of deposit broker. The 2020 final rule, in addition to narrowing the definition of deposit broker, exempted certain types of deposit placement arrangements previously considered by the FDIC staff to be brokered.
The 2020 final rule was adopted to clarify the regulatory framework for classification of brokered deposits, which had been developed by the FDIC staff over the course of several decades, largely through FDIC advisory opinions and other published or unpublished interpretative guidance. Industry participants generally viewed that framework as fragmented and opaque, and ill-suited to address technological and practical changes in the banking sector. Many industry participants therefore welcomed the clarifications provided by the 2020 final rule. However, certain aspects of the 2020 final rule led to new uncertainties, which, according to the FDIC, raises concern around the misreporting of brokered deposits.
Recent Developments
In the NPRM, the FDIC states that, following adoption of the Trump-era 2020 final rule, the agency has observed "a significant decline in reported brokered deposits." Notably, IDIs reported a 31.8 percent decline in brokered deposits between the first and second quarters of 2021 — the largest quarterly decline since the agency began requiring the reporting of brokered deposits in 1983. The significant decline in reported brokered deposits, according to the FDIC, was the likely result of a reclassification of a considerable amount of deposits held by IDIs in response to the 2020 final rule. The NPRM states that, despite these developments, as of the fourth quarter of 2023, brokered deposit balances across all IDIs were 22.5 percent higher than the first quarter of 2021 — which was the quarter before the 2020 final rule took effect. Among other things, the FDIC cites increased competition for deposit funding as a reason for the increase in brokered deposits, and expresses concern in the NPRM of the "precarious nature" of certain intermediated deposit placement arrangements in light of current market conditions.
Additionally, the FDIC asserts that amendments from the 2020 final rule have "proved to be problematic" for the safety and soundness of certain IDIs and their financial technology company partners. For instance, the recent failure of financial technology company Voyager, which was exempted from the deposit broker definition under the 2020 final rule because of an exclusive deposit arrangement exception, created the same legal, operational, and liquidity risks for its partner IDI as would have a deposit broker, according to the agency.
Proposed Revisions to the Brokered Deposits Framework
In the NPRM, the FDIC has proposed the following Amendments to the brokered deposits regulatory framework:
- Brokered Deposits Definition. The Amendments would revise the deposit broker definition by (1) consolidating certain prongs under the current definition, including the "engaged in the business of placing deposits" and the "engaged in the business of facilitating the placement of deposits" prongs; (2) removing the term "matchmaking activities" from the definition and replacing it with a deposit allocation provision; and (3) adding a new factor related to fees.
- Exclusive Deposit Arrangement Exception. Under the 2020 final rule, brokered deposit restrictions do not apply where a third party, which otherwise meets the definition of deposit broker, has an exclusive deposit arrangement with one IDI. The proposed Amendments would eliminate the "exclusive deposit arrangement exception" and restore the FDIC regulation's applicability to third parties that otherwise meet the definition of deposit broker but are involved in placing deposits at only one IDI.
- "Primary Purpose" Exception. The proposed Amendments would revise the standard for determining when a third party meets the "primary purpose" exception to the deposit broker definition. The exception would apply only when "[a]n agent or nominee whose primary purpose in placing customer deposits at [IDIs] is for a substantial purpose other than to provide a deposit-placement service or to obtain FDIC deposit insurance with respect to particular business lines between the [IDI] and the agent or nominee." The revised standard would be similar to how the FDIC historically interpreted the primary purpose exception prior to the 2020 final rule, including considering whether fees were paid to a third party to determine whether the third party's primary intent, or primary purpose, was the placement of deposits.
- "25 Percent AUA" Test. Under the 2020 final rule, third parties that swept customer funds to IDIs were eligible for the primary purpose exception under the designated "25 percent of assets under administration (AUA)" test, whereby less than 25 percent of that party's total AUA for its customers could be placed at IDIs. Due, in part, to reporting issues associated with this test, the FDIC has proposed to revise and rename the test to the "Broker-Dealer Sweep Exception." This exception would be available only to broker-dealers or investment advisers registered with the Securities and Exchange Commission and with less than 10 percent of total AUA for customers, in a particular business line, placed into non-maturity accounts at IDIs.
- "Enabling Transactions" Test. The 2020 final rule created the "enabling transactions" test for the primary purpose exception, which exempted third parties that placed 100 percent of customer funds at IDIs into transaction accounts with no fees, interest, or other remuneration to the depositor, subject to certain notice requirements. Because the current enabling transactions test would not satisfy the standard for reliance upon the primary purpose exception under the proposed Amendments, the FDIC has proposed eliminating the enabling transactions test and corresponding notice process.
- Application and Notice Processes. Under the proposed Amendments, the FDIC would no longer allow third parties to apply for a primary purpose exception. Instead, each IDI wishing to rely on a primary purpose exception would be required to submit an application for the specific deposit placement arrangement with a third party. Moreover, the FDIC would rescind all notices and applications approved under the 2020 final rule.
- "Agent Institution" Status & Reciprocal Deposits. Under Section 29 of the FDIA and the FDIC's Reciprocal Deposits Rule, an IDI that qualifies as an "agent institution" may except a certain amount of reciprocal deposits — deposits received through a deposit placement network between IDIs — from treatment as brokered deposits. Although the FDIC's Reciprocal Deposits Rule sets forth qualifying provisions to obtain agent institution status, the rule does not address how an IDI may regain that status once lost. Recognizing that neither statute nor regulation provide clarity on the issue, the proposed Amendments would provide a path for an IDI to regain agent institution status.
Comments Requested by the FDIC
The NPRM contains several specific requests for public comment on various aspects of the proposed rule. For example, the FDIC has sought comment on, among other topics, the following important issues:
- Whether the consideration of fees is appropriate when determining whether a person is a "deposit broker"
- Whether the proposed changes to the primary purpose exception application process are appropriate, including whether it is appropriate to limit the application process to insured depository institutions
- For the proposed Broker-Dealer Sweep Exception, whether the use of "assets under management" is appropriate
Comments will be due 60 days after the NPRM is published in the Federal Register.
Takeaways
The NPRM signals a desire by the FDIC to return to a pre-2020 framework for making brokered deposit determinations based upon the staff's view that many brokered deposit arrangements fundamentally are less "sticky" than core deposits, which is to say, such deposits are less likely to remain at any given bank in a fluctuating interest rate environment. In the NPRM, the FDIC notes that "less than well-capitalized IDIs may rely on less stable third-party deposits for rapid growth" or "as their condition is deteriorating," posing risks to the safety and soundness of IDIs and financial stability more broadly. To restrict such deposit-brokering activities, the FDIC has proposed to effectively shift the regulatory and reporting burden for deposit brokering activities back to IDIs, which may increase costs for IDIs and recalibrate their role in the brokered deposits regulatory framework.
footnotes
1 12 U.S.C. § 1831f.
2 12 C.F.R. § 337.6(a)(2).
3 12 C.F.R. § 337.6(a)(5).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.