The FDIC recently proposed a rule that would substantially change the 2020 final rule on brokered deposits that largely liberalized the FDIC’s framework. The proposed rule would eliminate many of the changes from 2020 and return to a more restrictive and cautious approach that could affect many banks and non-banks by bringing more entities under the brokered deposits regulation and classifying more deposits as brokered. Public comments are due 60 days after publication in the Federal Register. We expect many commenters will participate in this rulemaking, both because of its importance and following the Loper decision curtailing agency rulemaking discretion. Please reach out to the authors if you would like help commenting on this important development.
The FDIC also released a request for information and comment about deposits that is expected to inform supervisory efforts, receiverships, pricing deposit insurance premiums, and any future reforms to FDIC deposit insurance.
Key Takeaways
- Big changes. The proposed rule would materially change important aspects of the 2020 deposit broker regulation based on a perception of a majority of the current FDIC board of directors that these deposits or their relationships are too risky, overlooked, or underreported. The proposed rule would:
- Change the regulatory definition of “deposit broker”
- Eliminate the exclusive deposit placement arrangement exception
- Eliminate the enabling transactions designated business exception
- Change the interpretation of the primary purpose exception (PPE) and consider the third party’s intent in placing customer funds at a particular IDI
- Allow only banks to file notices and applications for PPEs, rather than non-banks
- Change the “25% test” designated business exception for a PPE to be available only to broker-dealers and investment advisers and only if less than 10% of the total assets that the broker-dealer or investment adviser has under management for its customers is placed at one or more banks
- Clarify how a bank may regain its agent institution status for the limited exception for reciprocal deposits
- More costly, more regulatory implications. If more deposits are categorized as brokered deposits, potentially fewer banks will be able to rely on them. Banks must be well capitalized to accept brokered deposits, absent the specific approval of the FDIC. In an era of increasing supervisory scrutiny, and possibly more stringent capital rules, among other economic and policy dynamics, deposits that are currently easier to obtain and less costly may become more difficult to obtain and more costly to maintain. In addition, fintechs that partner with banks to provide various financial services typically seek to avoid the brokered deposit designation out of operational concerns, including if a bank partner ceases to be well capitalized.
- Potentially less transparency. The 2020 brokered deposit regulation created a relatively transparent and straightforward process, notwithstanding any potential changes or refinements that could be needed based on recent market events. It largely coincided with the development of the Federal Reserve’s standardization and codification of its “controlling influence” framework. Any return to a potentially opaque, inconsistent approach to brokered deposits by the FDIC (like “subtle hermeneutics of [agency] lore” and “gnostic secrets”) would be regrettable and problematic.
- Post-Chevron considerations. It is not clear the FDIC has presented enough evidence—data or otherwise—to support the claims it makes about many of the deposits that would be covered by the proposed rulemaking. While the FDIC articulates the policy impetus and gives notable, recent anecdotes, we expect industry in the comments and possibly in a legal challenge to present data showing that the proposed rule does not accurately characterize the risk of many of the deposits that would be covered by the proposed rule. It is possible the FDIC has more data to support its position. But it may be argued that any such data is not in the record of the rulemaking thus far. Industry will also likely present additional data and information about consumer benefits and preference.
Background
Brokered deposits are an important policy concern. For decades, the FDIC has been concerned about hot money that can be easy placed with and just as easily removed from banks, leading to fundamental unsoundness. The backdrop of the 2023 spring bank failures and the failure of a crypto exchange and a bank–fintech intermediary firm have only heightened these risks.
But the financial services industry and market for deposits have fundamentally changed since Congress first grappled with brokered deposits decades ago. The FDIC’s action comes at a time when many banks are looking to attract deposits, increase liquidity, meet the needs of their communities, and diversify their offerings nationally and digitally, and when fintechs and other non-banks are looking to participate in a financial system that has not completely modernized its regulatory framework.
The FDIC, unfortunately, has not reached an institutional view that strikes a meaningful balance between the two policy concerns of safety and soundness on the one hand and financial modernization on the other. The absence of a stable policy on brokered deposits may be a function of the FDIC’s increasingly politicized board of directors. For the time being, there will be a degree of uncertainty for market participants amid a challenging economic environment and heightened supervisory and enforcement scrutiny that has targeted bank balance sheets and safety and soundness, among other issues.
Certain irregularities in the draft proposed rule suggest that it was prepared in haste. These will likely be cleaned up before publication in the Federal Register, thus delaying the comment period a bit. Nevertheless, it is possible that a final rule could be finalized by the end of 2024. Any final rule could be challenged on Administrative Procedure Act grounds or otherwise, as well as under the Congressional Review Act.
Banking-as-a-Service (BaaS) arrangements
The proposed changes could substantially affect many BaaS arrangements, which banks use to provide products and services to the customers of fintechs and other non-bank partners. These arrangements are typically structured to avoid the BaaS partner’s designation as a deposit broker.
The proposed rule, however, would eliminate exceptions that banks and BaaS partners have used to structure these arrangements. These changes would be expected to alter the economics of these arrangements, among other knock-on effects, and some banks and BaaS partners would be expected to essentially redesign or forgo some arrangements. The proposed changes come at a time when the federal banking regulators have increased their scrutiny of BaaS arrangements, as discussed in several of our prior client alerts, including with respect to recently issued guidance on risk management in this space.
Non-banks outside of BaaS arrangements
Many non-banks deposit money at banks for various reasons, including outside of BaaS arrangements. Many entities that rely on the PPE and notices previously granted (the FDIC currently maintains a list) would be expected to lose those designations and have to comply with the new rule, if finalized as proposed. Entities expected to be affected would include various payment processors, broker-dealers, and investment advisers, among others, including those involved in novel digital assets.
The PPE would be reworked to apply when the placing of deposits is for “a substantial purpose other than to provide a deposit-placement service or to obtain FDIC deposit insurance with respect to particular business lines between the individual insured depository institutions and the agent or nominee” (emphasis added). This is not a clear standard that lends itself to even application: when precisely is a purpose “primary” and yet not “substantial”?
The FDIC explains in the preamble that it would view a third party placing funds for the primary purpose of providing FDIC deposit insurance to third parties as not meeting this statutory exception. The FDIC views the purpose of providing FDIC insurance coverage as indistinguishable from the placement of deposits, and thus, absent another exception or determination, many deposits in bank-fintech partnerships could be reclassified as brokered.
Bank-only applicants. The elimination of a mechanism for non-banks to apply for PPEs would mean non-banks could not get pre-cleared and then approach banks. Instead, banks would have to effectively petition on the non-bank’s behalf, which would likely increase the number of applications the FDIC receives and the time required to review them.
New and narrowed “Broker-Dealer Sweep Exception. Changing the “25% test” designated business exception for a PPE, so that (1) it is available only for broker-dealers and investment advisers and (2) only if less than 10% of the total assets under management for its customers is placed at one or more banks, would narrow the current exception. The exception would be available only if the bank does not receive the FDIC’s written disapproval within 90 days, which can be extended further.
No additional parties could be involved in these arrangements to meet the exception; if they are, a specific application would be required.
Fees and remuneration
The proposed rule would significantly expand when a person is engaged in the business of placing or facilitating the placement of deposits to include any situation where the person has a relationship or other arrangement with a bank (or customer) where the bank (or customer) pays the person a fee or provides other remuneration in exchange for deposits being placed at a bank.
The FDIC points out in the preamble—but not in the proposed rule—that “passive listing services” that only advertised information on interest rates offered by banks on deposit products would not meet the deposit broker definition. However, other arrangements, fee structures, and advertising activities would need to be carefully analyzed.
Elimination of the exclusive deposit placement arrangement exception
Under Section 29 of the FDI Act and the FDIC regulations, the meaning of “brokered deposit” largely turns on the definition of the term “deposit broker.” In a world without Chevron deference, the proposed elimination of the 2020 exclusive deposit placement arrangement exception appears to be on a collision course with a challenge under Loper’s framework. Specifically, “deposit broker” is defined in statute in pertinent part as:
any person engaged in the business of placing deposits, or facilitating the placement of deposits, of third parties with insured depository institutions or the business of placing deposits with insured depository institutions for the purpose of selling interests in those deposits to third parties.
Thus, the statutory language speaks of relationships with more than one bank. And from this reading, the FDIC in 2020 developed an exception for any person that only placed or facilitated the placement of deposits at one bank.
The FDIC’s preamble to the proposed rule points to specific market developments to explain why the exclusive deposit placement arrangement exception is no longer appropriate in its view. The FDIC also engages in some statutory construction in its preamble—a foretaste of how it will argue against any future challenge, but also likely a reflection of the kind of additional details in rulemakings we are likely to see moving forward post-Chevron. And while the FDIC looks to 1 U.S.C. § 1 to explain that “words importing the plural include the singular, unless the statutory context indicates otherwise” (emphasis added), it is not clear how much the FDIC has engaged with this last clause, particularly since the very next provision in the definition (not reproduced above) uses the singular.
