This article originally appeared in the January 2021 edition of the WBA Compliance Journal, click here to view the full edition.

On December 15, 2020, the Federal Deposit Insurance Corporation (FDIC) finalized rules designed to modernize its existing brokered deposit rules. Brokered deposits are funds managed by a deposit broker. Meaning, an individual who accepts and places funds in investment instruments at financial institutions, on behalf of others. 

The final rule establishes a new framework for determining who is a “deposit broker.” It also amends the methodology for calculating the national rate, national rate cap, and the local market rate cap. Lastly, it explains when nonmaturity deposits are accepted and when nonmaturity deposits are solicited for purposes of applying the brokered deposits and interest rate restrictions. This article provides background information on what brokered deposits are, and focuses on two aspects of the final rule: the definition of “deposit broker” and interest rate restrictions.

Background

Significance of Regulation under Current Rules

Brokered deposits are a significant source of assets for some institutions. However, despite being a potential source of liquidity, many institutions avoid brokered deposits entirely due to complex regulation that often renders them impractical despite their utility as a deposit tool.

Application of the brokered deposit regulation is sweeping and complex, including sub-categories such as sweep programs, reciprocal deposits, and general purpose prepaid cards. FDIC has broad discretion in application of its rules, which involves complex methodologies for determining and adjusting rates. Furthermore, during the period of rulemaking, FDIC issued nearly 100 interpretations, advisories, and studies attempting to clarify who is a deposit broker. 

As technologies continue to evolve, and the financial industry follows those trends, the brokered deposit regulation, designed before the age of online banking, has become outdated. For example, the sweeping coverage of the regulation means institutions seeking deposits through the internet could be subject to interest rate caps.

At first glance, the regulation’s rate cap limitations may only seem to harm community banks, but it is an issue that affects banks both small and large. On the community bank side, FDIC bases the caps on what larger banks offer. In reality, the result can easily become a cap based on factors beyond what the community bank may be able to offer. By rule, the rate caps only apply to less than well capitalized institutions. However, regulators have looked to the limits during exams, regardless of capital levels, pointing to potential volatility. Furthermore, under its 2009 calculation method, current rate caps lag behind what a customer may obtain from other sources, such as the Treasury.

Legal Background

As a matter of statutory framework, Section 29 of the Federal Deposit Insurance Act (FDI Act) restricts the acceptance of deposits by certain insured depository institutions (IDIs) from a deposit broker. In summary, the law’s original restrictions include:

  1. Limiting acceptance of brokered deposits to well capitalized IDIs.
  2. Less than well capitalized institutions may only offer brokered deposits under certain circumstances, and with restricted rates.

The inception of brokered deposits came with the ability to transfer funds electronically. Technologies made it quick, easy, and cheap to access un-reached markets. With brokered deposits came greater bank liquidity and growth. After the 1980 financial crisis, FDIC’s study of brokered deposits lead to rules written in 1989 and amended in 1991 as the product and its use was believed to be riskier than traditional core deposits. 

In 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act amended Section 29 of the FDI Act to except a capped amount of certain “reciprocal deposits” from treatment as brokered deposits. On February 6, 2019, FDIC published an advance notice of proposed rulemaking and request for comment on unsafe and unsound banking practices: brokered deposits and interest rate restrictions (ANPR). A proposed rule followed on February 10, 2020. WBA commented on both the ANPR and the proposed rule. FDIC has now issued a final rule. The final rule takes effect on April 1, 2021, with mandatory compliance by January 1, 2022.

Summary of Final Rule

The final rule establishes a new framework for analyzing certain provisions of the “deposit broker” definition, including “facilitating” and “primary purpose.” In the final rule, FDIC designates certain business relationships as meeting the primary purpose exception and allows IDIs and third parties that wish to utilize the primary purpose exception but do not meet one of the designated exceptions to apply for a primary purpose exception.

The final rule’s interest rate restrictions relate to less than well capitalized IDIs. Under the final rule, FDIC amended the methodology for calculating the national rate and national rate cap for specific deposit products. The national rate would be the weighted average of rates paid by all IDIs on a given deposit product, for which data are available, where the weights are each institution’s market share of domestic deposits. 

Definition of “Deposit Broker”

Section 29 of the FDI Act provides that a person is a “deposit broker” if they are engaged in the business of placing deposits, or facilitating the placement of deposits, of third parties with IDIs or the business of placing deposits with IDIs for the purpose of selling interests in those deposits to third parties. The definition also includes 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 statute does not further define the categories that make up the definition of “deposit broker.” The final rule defines “deposit broker” as follows:

  • Any person engaged in the business of placing deposits of third parties with 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 discussion below elaborates on the first three bullet points of the final rule’s definition of deposit broker.

Engaged in the Business of Placing Deposits

The amended definition provides that a person is engaged in the business of placing deposits of third parties if that person receives third party funds and places those funds at more than one IDI. FDIC considers a person to be engaged in the business of placing deposits if that person has a business relationship with its customers, and as part of that relationship, places deposits with IDIs on behalf of the customer. Thus, the final rule amended the first bullet point of the “deposit broker” definition by providing that the person must have a business relationship with its customers, and as part of that relationship, receive customer funds and place those funds with IDIs on behalf of the customer. 

Engaged in the Business of Facilitating the Placement of Deposits

The “facilitation” part of the definition refers to activities where the person does not directly place deposits on behalf of its customers with IDIs. Under the final rule, a person is engaged in the business of facilitating the placement of deposits of third parties with IDIs, by, while engaged in business, with respect to deposits placed at more than one IDI, engaging in one or more of the following activities: 

  • The person has legal authority, contractual or otherwise, to close the account or move the third party’s funds to another IDI; 
  • The person is involved in negotiating or setting rates, fees, terms, or conditions for the deposit account; or 
  • The person engages in matchmaking activities.

The activities that result in a person being “engaged in the business of facilitating the placement of deposits” is intended to capture activities that indicate that the third party takes an active role in the opening of an account or maintains a level of influence or control over the deposit account even after the account is open. Having a certain level of influence over account opening or retaining a level of control over the movement of customer funds after the account is open, indicates that the deposit relationship is between the depositor and the person rather than the depositor and the IDI.

It is worth discussing a portion of the proposed rule to better understand why FDIC has finalized certain aspects of the rule as discussed above. Under the proposed rule, a number of entities, such as financial technology companies that partner with financial institutions through the regular course of business including data processing, web servicing, consulting, and advertising would have met the “deposit broker” definition. A number of groups, including WBA, commented that inclusion of such businesses would be inappropriate. In the final rule, FDIC agreed this was an unintended consequence. 

Thus, under the final rule, any person that has an exclusive deposit placement arrangement with one IDI and is not placing or facilitating the placement of deposits at any other IDI, will not be “engaged in the business” of placing, or facilitating the placement of, deposits and therefore will not meet the “deposit broker” definition. FDIC notes that under these arrangements, the third party has developed an exclusive business relationship with the IDI and, as a result, is less likely to move its customer funds to other IDIs in a way that makes the deposits less stable.

Engaged in the Business of Placing Deposits with IDIs for the Purpose of Selling Interests

This part of the definition specifically captures brokered certificates of deposit (CDs). These are typically deposit placement arrangements where brokered CDs are issued in wholesale amounts by an institution seeking to place funds under certain terms and sold through a registered broker-dealer to investors, typically in fully insured amounts. 

FDIC noted in the final rule that it intends that third parties that assist in the placement of brokered CDs, or any similar deposit placement arrangement with a similar purpose, will continue to be considered deposit brokers under this part of the deposit broker definition, regardless of any future innovations or re-structuring in the brokered CD market.

Exceptions to the Definition of “Deposit Broker”

FDI Act Section 29 provides nine statutory exceptions to the definition of deposit broker and FDIC has previously established one regulatory exception to the definition. Originally, FDIC had proposed revisions to the following two exceptions:

  • The exception for an IDI, with respect to funds placed with that depository institution (IDI exception). 
  • The exception for an agent or nominee whose primary purpose is not the placement of funds with depository institutions (primary purpose exception).

The final rule takes a different approach than the proposed rule, as discussed below.

IDI Exception

The final rule did not adopt the proposed changes to the IDI exception. However, the final rule does provide some discussion with regard to why, including treatment of “dual-hatted” employees, which is worth noting.

The IDI exception excludes an IDI from the definition of deposit broker when it, or its employee, places funds at the institution. FDIC proposed changes to expand the IDI Exception to permit wholly owned subsidiaries that meet certain criteria to be eligible for the exception. As discussed above, the final rule’s definition of deposit broker does not include third parties that have an exclusive deposit placement arrangement with one IDI. Thus, wholly owned subsidiaries that would have met the proposed IDI exception, will not meet the “deposit broker” definition under the final rule. Thus, FDIC determined that expansion of the IDI exception was no longer necessary.

However, FDIC did take a moment in the final rule to discuss applicability of the IDI exception to “dual-hatted” or “dual” employee. FDIC noted that the statutory “employee” exception applies solely to an “employee” who satisfies the definition of an employee provided by the statute. The statute defines an “employee” as any employee: 

  • Who is employed exclusively by the IDI; 
  • Whose compensation is primarily in the form of a salary; 
  • Who does not share such employee’s compensation with a deposit broker; and 
  • Whose office space or place of business is used exclusively for the benefit of the IDI, which employs such individual.

FDIC stated that the exception does not apply to a contractor or dual employee because they are not employed exclusively by IDIs. The exception would, however, apply to “dual-hatted” employees that are employed exclusively by the institution so long as the employees meet each of the other statutory elements of the “employee” definition.

Primary Purpose Exception

Under the final rule, the primary purpose exception applies when, with respect to a particular business line, the primary purpose of the agent’s or nominee’s business relationship with its customers is not the placement of funds with depository institutions, and whether an agent or nominee qualifies for the primary purpose exception will be based on analysis of the agent’s or nominee’s relationship with those customers.

The final rule also identifies a number of specific business relationships, known as “designated business exceptions,” as meeting the primary purpose exception. Additionally, businesses that do not qualify for a designated exception may submit an application to FDIC for consideration under the primary purpose exception. Please refer to the final rule for the full list of business relationships that qualify for the designated exceptions.

Interest Rate Restrictions

Under Section 29 of the FDI Act, well capitalized institutions are not subject to any interest rate restrictions. However, the statute imposes interest rate restrictions on IDIs that are less than well capitalized, as defined in Section 38 of the FDI Act. The statutory interest rate restrictions generally limit a less than well capitalized institution from offering rates on deposits that significantly exceed rates in its prevailing market.

Under current regulations, an institution that is not well capitalized generally may not offer deposit rates more than 75 basis points above the national rate for deposits of similar size and maturity. The national rate is currently defined as a simple average of rates paid by all IDIs and branches that offer and publish rates for specific products. If an institution believes that the posted national rates do not represent the actual rates in the institution’s local market area, the institution may present evidence to FDIC that the prevailing rate in a particular market is higher than the national rate. If FDIC agrees with the evidence, the institution would be permitted to pay as much as 75 basis points above the local prevailing rate for deposits solicited in its local market area. 

The final rule amends FDIC’s methodology for calculating the national rate, the national rate cap, and the local rate cap. The final rule also provides a new simplified process for institutions that seek to offer a competitive rate when the prevailing rate in an institution’s local market area rate exceeds the national rate cap. The following highlights changes made by the final rule.

National Rate Methodology and National Rate Cap

The final rule adopts the national rate methodology generally as proposed but revised it to include the rates offered by credit unions. 

The national rate cap now is the higher of: 

  1. The national rate (weighted average of rates paid by all IDIs and credit unions on a given deposit product, where the weights are each institution’s market share of deposit deposits), plus 75 basis points; or
  2. 120 percent of the current yield on similar maturity U.S. Treasury obligations, plus 75 basis points, or in the case of nonmaturity deposits, the federal funds rate plus 75 basis points. 

Local Market Rate Cap

The final rule adopts a local market rate cap of 90 percent of the highest offered rate in the institution’s local market geographic area. A less than well capitalized institution would be permitted to provide evidence that any bank or credit union with a physical presence in its local market area offers a rate on a particular deposit product in excess of the national rate cap. The local market area could include the State, county, or metropolitan statistical area, in which the IDI accepts or solicits deposits. 

The final rule also eliminates the current two-step process where less than well capitalized institutions request a high rate determination from FDIC and, if approved, calculate the prevailing rate within local markets. Instead, a less than well capitalized institution would be required to notify FDIC that it intends to offer a rate that is above the national rate cap and provide evidence that an IDI or credit union with a physical presence in the less than well capitalized institution’s normal market area is offering a rate on a particular deposit product in its local market area in excess of the national rate cap.

Conclusion

The final rule represents long-awaited changes to brokered deposit rules. As discussed above, the final rule establishes a new framework for the definition of who is a “deposit broker” and methodology for calculating the national rate and national rate cap for certain deposit products. 

The final rule is effective on April 1, 2021. The mandatory compliance date is January 1, 2022. Entities may begin relying upon the provisions of the final rule as of April 1, 2021, and will have to comply with any applicable reporting requirements. It is also worth noting that the mandatory compliance date of January 1, 2022, permits entities to continue reliance upon existing staff advisory opinions or other interpretations until that date. However, upon January 1, 2022, previous staff advisory opinions will be moved to inactive status.

It is also important to note that due to the recent change in the federal administration, it is possible a delay in the implementation of the final rule may occur as a result of the new administration reviewing the rule. The review of a rule that has been finalized but not yet published, or is not yet effective, is a routine review any time there is a change in administration. WBA will continue to monitor the status of this and other rules under review. The notice may be viewed at: www.whitehouse.gov/briefing-room/presidential-actions/2021/01/20/regulatory-freeze-pending-review/ 

The final rule may be viewed at: https://www.govinfo.gov/content/pkg/FR-2021-01-22/pdf/2020-28196.pdf