FDIC Publishes Brokered Deposits Proposed Rule

On February 10, 2020, the Federal Deposit Insurance Corporation (FDIC) published a proposed rule intended to modernize the regulatory treatment of brokered deposits (Proposed Rule). The Proposed Rule would amend 12 C.F.R. Parts 303 and 337 to set forth the regulatory scheme for determining whether deposits placed through deposit placement arrangements are classified as brokered deposits. The Proposed Rule follows a February 2019 FDIC advance notice of proposed rulemaking on this issue.

In the course of its rulemaking proceedings, the FDIC has acknowledged the significant changes in technology, business models, and deposit products that have occurred since Section 29 of the Federal Deposit Insurance Act was enacted in 1989. FDIC leadership has repeatedly called for the modernization of the brokered deposit regime since the advance notice of proposed rulemaking was published in February 2019. For example, in a December 11, 2019 speech introducing the Proposed Rule, FDIC Chairman Jelena McWilliams set forth four goals for the new framework:

• Encouraging innovation within the industry that allows banks to “serve customers the way customers want to be served”;
• Taking a balanced approach to interpreting Section 29 that “tracks the letter and spirit of the law”;
• Minimizing risk to the Deposit Insurance Fund, and ensuring that the agency addresses the core problems that Congress sought to address in enacting Section 29; and
• Establishing an administrative process that “emphasizes consistency and efficiency,” with a “bright-line standard” for determining whether an entity is a deposit broker.

However, in certain respects, the provisions of the Proposed Rule do not align with FDIC leadership’s stated goals. For example, the Proposed Rule could make it more difficult for banks to serve customers the way customers want to be served, by including as brokered deposits all deposits enabled through a bank service provider, or otherwise forcing such arrangements through a new primary purpose exception application process. Moreover, the Proposed Rule does not codify in Part 337 the types of bright-line standards for determining whether a deposit is brokered that FDIC leadership has alluded to in public statements.

At a high level, the Proposed Rule would: (1) add a definition of “facilitating the placement of deposits” to the definition of “deposit broker”; (2) amend the “primary purpose” exception to the definition of deposit broker; (3) extend the exception for insured depository institutions (IDIs) to wholly owned operating subsidiaries of parent IDIs; and (4) expressly designate brokered CDs as brokered deposits.

Facilitating the Placement of Deposits

The Proposed Rule would add a new subsection 6(a)(5)(ii) to the definition of deposit broker that sets forth the meaning of the term “engaged in the business of facilitating the placement of deposits of third parties.” Specifically, under proposed new subsection 6(a)(5)(ii), a person would be engaged in the business of facilitating the placement of deposits of third parties with IDIs by:

• Directly or indirectly sharing any third-party information with the IDI;
• Having legal authority, by contract or otherwise, to close the account or move the third party’s funds to another IDI;
• Providing assistance with, or being involved in, setting rates, fees, terms, or conditions for the deposit account; or
• Acting, directly or indirectly, with respect to the placement of deposits, as an intermediary between a third party that is placing deposits on behalf of a depositor and an IDI, other than in an administrative capacity.

This broad definition could result in even more deposits being classified as brokered. For example, there are a wide range of service providers—ranging from bank consultants to core system providers—that share third-party information with an IDI. The Proposed Rule could have the effect of sweeping all such third parties into the definition of facilitating the placement of deposits.

Moreover, IDIs—and community banks, in particular—often lack the resources, budgets, and technical expertise to develop and deploy innovative products and services to the communities they serve, and the IDIs rely on third-party service providers to make innovative products and services available to consumers. For example, many community banks rely on third-party consultants, among others, to provide assistance with developing competitive pricing and terms for deposit products. An overly broad rule that would render as brokered deposits any deposits placed with the assistance of a consultant that also helps the IDI to determine account pricing or terms, would inhibit innovation and limit the ability of community banks to serve customers in the manner they want to be served—notwithstanding the fact that in many of these arrangements, the IDI ultimately determines the account terms and pricing offered directly to the individual depositor customer, and the third party has no control over the terms or the depositor relationship.

Primary Purpose Exception

The Proposed Rule also would amend the existing “primary purpose” exception to the definition of deposit broker. This exception applies when the primary purpose of an agent’s or nominee’s business relationship with its customers is not the placement of funds with IDIs. As a result, the Proposed Rule would force all applicants for the primary purpose exception through an application process that would be codified in Part 303.

The application process includes three new tests to determine whether a business relationship meets the primary purpose exception. The primary purpose of an agent’s or nominee’s business relationship with its customers would not be considered to be the placement of funds if:

• Less than 25 percent of the total assets in a particular business line that the agent or nominee has under management for its customers is placed at IDIs (the “broker-dealer sweep test”);
• The business purpose of the agent or nominee is to place 100 percent of depositors’ funds into transactional accounts at IDIs for the purpose of enabling customers to make payments, and no fees, interest, or other remuneration is provided to the depositor (the “transaction account test”); or
• If neither of the above tests applies, the agent or nominee can demonstrate that the primary purpose of the agent or nominee is something other than the placement of funds at IDIs (the “catch-all test”). 

These tests purport to be the bright-line standards that FDIC leadership sought to include in the modernized framework; however, there are important questions concerning the application of these tests. For example, as it relates to the scope of the broker-dealer sweep test and the transaction account test, the FDIC will need to address whether assets under management is the appropriate measure for the broker-dealer sweep test, and whether the transaction account test would unintentionally exclude products like reward checking accounts based on its prohibition on remuneration provided to depositors. Moreover, as part of the transaction account test, the Proposed Rule would require that an applicant “demonstrate[] that the primary purpose of the particular business line … is to enable its customers to make transactions”; however, it is not clear in the text of the Proposed Rule what would be required for purposes of making such a demonstration.

Under the catch-all test, the FDIC would consider (1) the source of the majority of the revenue of the agent or nominee; (2) whether the agent’s or nominee’s marketing to prospective depositors is aimed at opening a deposit account or to provide some other service; and (3) the fees, and type of fees, received by an agent or nominee for any deposit placement service it offers. However, the catch-all test does not articulate within the text of Part 303 the type of bright-line standard that FDIC leadership sought. Instead, application of the catch-all test risks the same types of inconsistent and opaque rulings from the FDIC often found in the existing brokered deposit advisory opinions.

From a process perspective, the Proposed Rule would establish an application procedure for all third parties seeking exception approval under the primary purpose exception. Part 303 would require specific information as part of an application for the primary purpose exception. According to the Proposed Rule, applications submitted to the FDIC through the proposed process would receive a written determination from the FDIC within 120 days of a complete application. The Proposed Rule also would require ongoing reporting by companies that receive an exception approval.

Exception for Wholly Owned Subsidiaries of IDIs

The FDIC would extend the existing exception to the definition of deposit broker for IDIs to wholly owned operating subsidiaries of parent IDIs, under certain circumstances. Specifically, the subsidiary would be considered a part of the parent IDI if:  (1) the parent IDI owns 100 percent of the subsidiary’s outstanding stock; (2) the wholly owned subsidiary places deposits of retail customers exclusively with its parent IDI; and (3) the wholly owned subsidiary engages only in activities permissible for the parent IDI.

Clarification on Brokered CDs

Under the Proposed Rule, the FDIC would continue to consider an agent’s placement of brokered CDs as deposit brokering, and the deposits would continue to be reported as brokered. Brokered CD placements, which were the primary type of brokered deposit that prompted Congress to enact the brokered deposit restrictions in 1989, expressly would not be eligible for the primary purpose exception. An agent’s placement of brokered CDs would be considered a discrete and independent business line from other deposit placement businesses. Therefore the primary purpose for that particular business line will always be the placement of deposits at depository institutions, and such deposits would continue to be considered brokered deposits notwithstanding that the agent may not be considered a deposit broker for other deposits that it places.

Applicability of Prior Staff Advisory Opinions

In the supplementary information accompanying the Proposed Rule, the FDIC says it intends to evaluate existing staff opinions to identify the ones that are outdated based on revisions made to the brokered deposit regulations. As part of any final rule, the FDIC plans to codify staff opinions of general applicability that remain applicable and rescind those that do not. These statements by the FDIC create uncertainty in the near term for IDIs and third parties that rely on established advisory opinions, and the evaluation process could have an adverse impact on IDIs or third parties that could lose the basis for their historic classification of deposits without the procedural safeguards to which they should be entitled. 

The restrictions on brokered deposits under Section 29 and Part 337 apply directly to IDIs that are less than “well capitalized.” Nonetheless, the Proposed Rule could have a far broader impact. For example, classifying a deposit as “brokered” can impact a well-capitalized bank’s core deposit ratio, liquidity coverage ratio, and capital planning. In addition, IDIs may be reluctant to make significant investments in deposit programs that may be at risk if the IDI’s capital position changes.

The Proposed Rule includes twenty-six specific questions about the FDIC’s proposal. Answers to these questions, and comments on the Proposed Rule, are due by April 10, 2020.