Regulatory uncertainty causing slowdown in FDIC sweep deposit market

Uncertainty surrounding rules governing brokered deposits has caused a drastic slowdown in the FDIC’s  sweep deposit market.

A lack of guidance from banking regulators regarding the general treatment of FDIC sweeps and treatment of sweeps under new Basel III capital rules has also added to the growing uncertainty, American Banker reports.

Broker-dealers pile clients’ uninvested funds into money market deposit accounts, which are then placed with banks. Banks pay interest on the deposits, and part of the interest income is then passed on to the client. Under “pass-through” provisions of federal banking rules, the customer receives protection from the FDIC on their cash balances in the accounts placed with the banks.

Broker-dealers that participate in the FDIC sweep market have reported increased difficulty in finding banks to take their deposits, partly because banks have significant amounts of short-term liquidity as a result of loan growth and because banks have seen an increase in core deposits, according to American Banker.

Core deposits increased more than $700 billion between June 2011 and June 2012, somewhat due to continued unlimited protection from the FDIC through the Transaction Account Guarantee program. Banks’ need for deposits from broker-dealers has, therefore, decreased.

Basel III rules require banks to hold capital reserves in the form of liquid assets in order to cushion against economic blows and market shocks. The yield on liquid securities is far lower than that on loans and other assets, thereby increasing interest costs for the banks. Revenue is higher when funded by core deposits as opposed to a money market deposit account, American Banker reports.

Additionally, if a broker-dealer and bank enter into an agreement for a deposit account with a contractual maturity of more than one year and a penalty for early return of the deposit to the broker-dealer, the bank appears to be in the same position as it would be in regards to core deposits. The draft of Basel III rules, however, has led some institutions to speculate that the same contract would be treated as a CD with no low-yield, short-term liquid asset requirements.

Basel III rules do not refer to brokered deposits or FDIC sweep variations, leading many banks to avoid long-term contracts with broker-dealers until regulators address the uncertainty. It remains to be seen whether Basel III will be implemented in the U.S, according to American Banker.

Minus Basel III considerations, many banks already have various interpretations regarding the regulatory and accounting treatment of FDIC sweep deposits. Some institutions maintain that, as such deposits are always considered brokered, they are inherently less valuable than the equivalent core deposit.

Before the financial crisis of 2008, banks that held brokered deposits were required to pay higher FDIC insurance premiums on the account balances, thereby damaging the bank’s reported liquidity ratios. As a result of the 2010 Dodd-Frank Act, however, the Federal Reserve re-examined in 2011 the role of brokered deposits, American Banker reports.

The evaluation led regulators to conclude that well-capitalized banks would no longer be required to pay higher insurance premiums, FDIC field examiners were instructed to handle brokered deposits the same as any other deposit source and banks holding MMDAs were allowed to classify the deposits as core deposits rather than brokered deposits.

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