The Federal Deposit Insurance Corporation (FDIC) recently proposed significant changes to the rules governing “brokered deposits” at US banks. Specifically, the proposal would change the definition of “brokered deposits,” making it difficult to come up with a succinct legal definition. So a functional definition will have to do: The brokered deposit rules are designed to enhance bank safety and soundness by limiting the ability of banks to rely on a source of funding that is deemed to be risky and unreliable–to be “hot money” in the parlance.
Historically, deposits that were intermediated–or “brokered”--were considered to be high risk. Banks’ use of such deposits was limited by regulation, and under-capitalized banks were prohibited from using them altogether. Certificates of deposit, issued by banks and sold through brokers to customers seeking the highest available rates, were the original “hot money” targeted by the rules. And with good reason, as many savings and loan institutions that failed in the 1980s and early 1990s used brokered CDs to fuel rapid asset growth. (These were often Hail Mary attempts by the S&Ls to grow their way out of the holes blown in their mortgage-heavy balance sheets by the Volcker rate hikes. Some echoes worth noting.)
The brokered deposit rules, as adopted by Congress and implemented by the FDIC, treated many types of deposits that were intermediated in some fashion as “brokered.” But the brokered deposit statute was passed before the dawn of internet banking, let alone the mobile and fintech waves of the 2010s.
The recent FDIC proposal appears designed specifically to ignore–or possibly to put sand in the gears of–the structural changes underway in how banking services are delivered, and how consumers and businesses manage their money.
Digital banking, carried out online and increasingly on mobile phones, has enabled a proliferation of financial applications offering numerous ways to save, store, invest, move, and borrow money. Financial services are increasingly embedded seamlessly into everyday experiences.
Many – if far from all – of these applications have improved financial well-being, in large part by making it vastly easier for consumers to make the right decisions or for making the decisions for them–automated savings, round up features, robo advising for investments, financial planning that looks across all of a customer’s accounts. Indeed, the vast majority of positive financial innovation over the past decade has taken place outside the banking system.
We have not yet achieved the vision of “self-driving money,” but the road we are on is clearly headed in that direction, with generative AI the latest accelerant.
The result is a much more fragmented financial landscape. The days of customers and businesses managing their finances from a single bank account are long gone. Consider the following:
The average consumer has 5-7 different financial accounts
Half of new bank accounts are opened at digital banks/fintechs
PayPal and Chime account for 20% of all new account openings
Perhaps even more telling is the aftermath of Silicon Valley Bank’s failure: Businesses large and small moved rapidly to reduce their exposure to uninsured deposits at all but the largest banks–spreading it among a handful of banks, or pulling it out of banks altogether and buying short-term Treasury securities so the government (rather than a bank) would be their counterparty. The trend has stabilized, but there are still a large amount of uninsured deposits in the banking system and strong incentives for businesses and wealthy individuals to reduce their exposure to bank failure risk.
Account connectivity and the ability to seamlessly move funds between applications are critical. And customer funds must be able to trust their funds are safe. Money is increasingly moving to and through financial applications operated by nonbanks. In other words, a lot more money is now “intermediated” in some fashion and, under the proposed changes, would be deemed “brokered.”
Consider just this one part of the definition of deposit broker:
The person proposes or determines deposit allocations at one or more insured depository institutions (including through operating or using an algorithm, or any other program or technology that is functionally similar)
That would well describe any number of fintech applications.
Where does all this leave us? And what does it have to do with the brokered deposit proposal?
All money is not hot money, as some commentators have declared. But money is getting easier and cheaper and faster to move between accounts and into and out of close money substitutes. This means that businesses and consumers will focus more on optimizing how they handle their cash because they have more options and the gains of doing so are greater–they can receive higher yields *and* greater safety than are offered by uninsured deposits at commercial banks.
In other words, the “convenience yield” offered by transactional bank accounts will erode, forcing banks to compete ever harder for deposits. They can pay up, evaporating their net interest margins, or they can find stable sources of intermediated deposits.
There are real risks in this new world of more mobile money. But fintech program deposits and deposit sweep programs represent relatively stable funding, not the “hot money” that brokered deposit rules are intended to constrain.
The FDIC’s proposal seeks to turn the clock back, and will not only impede innovation but will likely have the effect of pulling more deposits out of the banking system, making life harder for most banks not named JP Morgan.
