Merriam-Webster is the oldest dictionary publisher in the United States. Americans have consulted the dictionary, which is named for George and Charles Merriam and Noah Webster, for nearly 200 years. Today’s Merriam-Webster dictionary, which you can access online or purchase in hardback, contains the definitions for more than 300K words.Of course, the definitions of words in Merriam-Webster’s dictionary change over time, due to slang, misinterpretations that become popularized, and gradual changes in society and language. As it turns out, the definitions of terms used by the Federal Deposit Insurance Corporation (FDIC) get the same treatment as well. Four years ago, the FDIC implemented changes commonly referred to as the 2020 Rule that loosened the definition of “deposit broker” and expanded the types of exceptions allowed under the new definition. This resulted in fewer deposits being classified as brokered deposits.In an about-face, the FDIC is now proposing a rule to amend the 2020 Rule and effectively undo these regulatory changes. In proposing this rule, the FDIC is seeking to address the underreporting of brokered deposits by some banks and reduce reliance by some banks on “hot money” to grow quickly.The FDIC Board approved the Proposed Rule on July 30, 2024, with a 60-day public comment period after publication in the Federal Register, which would have been October 22, 2024. In October, the FDIC extended the comment period to November 21, 2024 to provide additional opportunity for the public to prepare comments on the guidance.A Stricter Broker Deposit RegimeNot only would the Proposed Rule reverse the more liberal “deposit broker” definition, but it would also codify certain concepts like FDIC FAQs regarding brokered deposits and identifying brokered deposits and Advisory Opinions that only existed within FDIC guidance prior to the 2020 Rule. This could potentially create a stricter broker deposit regime than the one that existed before the 2020 Rule.Here are a few of the most critical changes noted in the Proposed Rule:
- The broader "deposit broker" definition would classify entities that place deposits and those that facilitate the placement of deposits under the same umbrella. The new definition would also aim to include third parties that receive fees from banks or customers as a result of placing deposits.
- The "exclusive deposit placement arrangement" exception would be eliminated, meaning an end to the exception for third parties that only place deposits with one bank.
- The primary purpose exception (PPE) interpretation would be revised to factor in whether the third party placing the funds has a substantial motive to do so beyond providing a deposit-placement service or ensuring FDIC protection for the depositor.
The expanded definition of deposit broker could capture a wider range of entities including fintech companies, asset managers, and non-bank deposit gatherers. Banks would be required to provide more detailed information about brokered deposits, including the identity of the deposit broker and the source of the funds (in alignment with risk management practices). In addition, the guidance could alter the treatment of “hot money” deposits, which are short-term deposits that may be susceptible to rapid withdrawals.The Proposed Rule could significantly impact the operations of community financial institutions (CFIs) in several different ways, starting with increased regulatory burdens. CFIs may need to invest in new systems, hire additional staff, or modify existing processes to meet the enhanced reporting requirements. This, of course, could lead to significantly higher regulatory compliance costs.The broader definition of a deposit broker could also limit the availability of funding sources for some CFIs, especially those that rely heavily on brokered deposits. It may also affect relationships between CFIs and fintech companies, since it might be more likely that fintechs are classified as deposit brokers. In addition, FDIC insurance premiums could increase for CFIs with a higher proportion of brokered deposits, which could impact profitability.Navigating the ChangesIf the proposed rule goes into effect, here are a few strategies to help your CFI effectively navigate the resulting changes:Regulatory Compliance
- Conduct a thorough assessment. Evaluate your CFI's current practices related to brokered deposits to identify potential gaps in compliance.
- Invest in technology. Implement or upgrade compliance software to automate reporting and reduce manual errors.
- Train your staff. Provide comprehensive training on the new regulatory requirements and best practices for compliance.
- Establish a compliance committee. Create a dedicated committee to oversee compliance efforts and ensure adherence to regulatory standards.
Funding Diversification
- Explore alternative funding sources. Consider diversifying your funding sources to reduce reliance on brokered deposits. For example, you could increase deposits from retail customers, issue debt securities, or form strategic partnerships with other financial institutions.
- Enhance customer relationships. Focus on building strong relationships with retail customers to encourage them to deposit funds with your CFI.
- Offer competitive interest rates and incentives. These may help your CFI attract and retain retail depositors.
Fintech Partnerships
- Evaluate your fintech partnerships. Review your existing partnerships with fintech companies to assess their potential impact under the new guidance.
- Consider alternative arrangements. Explore new types of arrangements with fintech companies that may reduce regulatory risks, such as joint ventures or licensing agreements.
- Stay informed about regulatory developments. Monitor developments that could affect your fintech partnerships and adjust strategies accordingly.
Risk Management
- Implement risk management frameworks. Develop robust risk management frameworks that are capable of identifying, assessing, and mitigating the risks associated with brokered deposits.
- Monitor trends and conditions. Stay informed about market trends and economic conditions that could impact the cost and availability of brokered deposits.
- Develop contingency plans. These plans should address potential disruptions in funding sources, such as increased regulatory scrutiny or economic downturns.
The FDIC's proposed guidance on brokered deposits presents a significant opportunity to assess your CFI’s practices, understand the potential implications, and take proactive steps to mitigate risks and capitalize on emerging opportunities. By staying informed, engaging with regulators, and adapting to the evolving regulatory landscape, you can position your CFI for long-term success.
