In making broad claims about links between brokered deposits and the safety and soundness of the banking system, the NPRM may be open to legal challenges
One of the most fundamental activities of an insured depository institution (IDI) is taking and safekeeping customer deposits. However, a recent proposed rulemaking by the Federal Deposit Insurance Corporation (FDIC) poses significant risk of further restricting how IDIs can attract deposits, increase sources of liquidity, and attract investment.
On July 30, 2024, the FDIC issued a Notice of Proposed Rulemaking (NPRM) that would reverse its own 2020 Final Rule, narrow the exceptions to the definition of "brokered deposits," and return to the status quo prior to 2020. "Brokered deposits" are deposits placed with an IDI through, or with the involvement of, certain types of intermediaries called "deposit brokers."[1] Section 29 of the Federal Deposit Insurance Act (FDI Act) imposes restrictions on a less than well-capitalized IDI from accepting brokered deposits.[2] In the FDIC's view, such restrictions are necessary because brokered deposits are allegedly "hot" money, not "sticky," and more prone to "run" in a crisis.[3] On the other hand, opponents of these restrictions say that brokered deposits can be crucial sources of funding for small IDIs who need to expand their balance sheets to stay competitive and for whom raising deposits may be difficult, too slow, or non-economic.
The 2020 Final Rule was adopted to clarify what activity qualified as "deposit brokering," which had previously been left to the interpretation of the FDIC's Office of the General Counsel through opinion letters. These opinion letters almost always found that such activity met the definition of deposit brokering and were often confusing or contradictory. With the 2020 Final Rule, the FDIC loosened the definition of a deposit broker. In particular, the 2020 Final Rule crafted exceptions for intermediaries who have an exclusive deposit arrangement with one IDI[4] and for businesses whose "primary purpose," with respect to a particular business line, is not the placement of funds with IDIs.[5] The 2020 Final Rule further defined the "primary purpose exception" to include businesses where 25% or less of its total assets under administration is placed with IDIs[6] and where 100% of deposits placed with IDIs are placed into transactional accounts that do not pay any fees, interest, or other remuneration to the depositor.[7]
The NPRM would do away with these exceptions and return to a framework where almost every deposit facilitation activity is treated as a brokered deposit, allegedly due to a significant decline in brokered deposits with the 2020 Final Rule. This is likely to be highly impactful for IDIs, as brokered deposits require higher deposit insurance premiums, are treated in a restrictive manner under the liquidity rules, are treated differently for capital retention purposes, and receive greater regulatory scrutiny from FDIC examiners, particularly at the small-bank level. The NPRM was greeted with hostility by industry trade groups and from some within the agency. The president of the American Bankers Association, Rob Nichols, said that the proposal "would restrict access to sources of liquidity while penalizing banks for pursuing funding sources that enable them to meet the needs of their communities."[8] FDIC Vice Chairman Travis Hill, in a speech at the American Enterprise Institute (AEI), stated that "it would be a mistake for the FDIC to substantively reopen the brokered deposits rule. Doubling down on the pre-2020 brokered deposits regime in 2024 is like doubling down on stone castles after the invention of cannons."[9]
Agency Rulemaking Under Greater Scrutiny
Agency rulemaking has recently faced a flurry of challenges in court based on an alleged absence of adequate analysis justifying the underlying regulation.[10] Ongoing challenges, particularly in the 5th Circuit, have underlined those potential flaws. For example, in a recent opinion vacating the U.S. Securities and Exchange Commission's (SEC) share repurchase rule, the 5th Circuit held that the SEC had not established that "opportunistic or improperly motivated buybacks" were "genuine problems" and failed to demonstrate that it considered relevant factors in concluding that the rule's additional disclosures would only impose relatively modest costs for issuers.[11] The Supreme Court also recently signaled that it is likely insufficient for agencies to make a loose connection between an old problem and their current desire for rulemaking. The rulemaking must be "reasonable and reasonably explained" with concrete examples of why the existing rule is not working.[12] Here, there may be a similar debate about whether the FDIC has made its case that the existing regulations on brokered deposits create "genuine problems" requiring amendment.
Scrutiny of the NPRM
Any final rule resulting from the NPRM may be subject to legal challenge under the Administrative Procedure Act (APA) for having flawed economic and related analyses and lacking a reasoned explanation. As a general matter, while economic and related analyses (often referred to as "cost benefit" or "regulatory impact" analyses) are not required by the APA, they are required by Executive Order 12866 and Office of Management and Budget (OMB) Circular A-4. Although these orders are not binding on independent agencies such as the FDIC, the FDIC has stated that "its policy is broadly consistent with the principles in OMB Circular A-4."[13] Under this framework, the NPRM has potential problems.
The FDIC stated that the NPRM offers two primary benefits: clarity of certain concepts for affected IDIs and improved safety and soundness of the banking system. However, as discussed above, the NPRM would return the regulation of brokered deposits to the pre-2020 regime that was marred by unclear and contradictory opinion letters issued by the FDIC's Office of the General Counsel. Moreover, there seems to be a gap between the regulatory need of the NPRM and any significant danger to the safety and soundness of the banking system. For example, as part of its analysis of need, the NPRM points to the bank failures during the global financial crisis of 2008 and 2009 and the recent bank failures of March 2023. The NPRM states that brokered deposit use was associated with higher probability of bank failure and higher losses to the Deposit Insurance Fund (DIF).[14] However, the NPRM does not cite any data indicating that the brokered deposits had any connection to bank failures causing losses to the DIF. Indeed, in Vice Chairman Hill's remarks at the AEI, he noted that when Silicon Valley Bank (SVB) failed "not a single one of its deposits was reported as brokered."[15] And, in his report on the SVB failure, Federal Reserve Board Vice Chair for Supervision Michael Barr did not cite brokered deposits as a predicate or contributing cause to the SVB failure.[16] Further, while the NPRM makes several references to the run on affiliated sweep deposits at First Republic Bank, the FDIC's own report on the failure of First Republic Bank does not cite a concern over brokered deposits, instead pointing to the high percentage of uninsured deposits at the bank and incorrect assumptions by the bank and the FDIC about the "stickiness" of large deposits from high net worth individuals.[17] Thus, the FDIC may have difficulty in justifying the need for a reversal of the 2020 Final Rule based on bank failures in either the distant or the recent past.
In addition, the NPRM notes that in the first quarter in which the 2020 Final Rule was in effect, IDIs reported almost $350 billion less in brokered deposits than in the previous quarter,[18] claiming that "certain deposit arrangements that would have been viewed as brokered prior to the 2020 Final Rule [were] no longer being classified as brokered, even though such deposits present the same or similar risks as brokered deposits."[19] However, the NPRM fails to note that in the post-2020 time period IDIs were awash with non-brokered deposits as a result of the COVID-19 pandemic and notes, but does not address, that the amount of brokered deposits had returned to "normal" levels by 2023.[20]
Lastly, as pointed out by Vice Chairman Hill, the NPRM represents an apparent contradiction in regulatory policy. While attempting to discourage the use of brokered deposits by IDIs that may be experiencing funding stress, the federal banking agencies have at the same time been trying to encourage more discount window borrowing for the same purpose, even though discount window borrowing suffers from greater stigma. Resolving such a seeming contradiction may pose a further challenge for the FDIC to support its reversal of the 2020 Final Rule.
Lost in the NPRM's focus on regulatory clarity and safety and soundness of the banking industry are the costs to IDIs, particularly smaller institutions. The FDIC indicates that it expects affected IDIs to incur some costs, including costs associated with restructuring liabilities, compliance with regulatory ratios, changes to organizational structures, changes to internal systems, increased filings, and higher deposit insurance assessments. Yet, the FDIC does not quantify the cost to IDIs, stating that it does not have the data to conduct an estimate. By merely acknowledging these costs in the NPRM, without any quantification, the FDIC may have opened itself up to another APA challenge.
It is impossible to say whether a final rule will be challenged, and it is also possible that the NPRM may be modified after the receipt and analysis of comments. However, organized opposition by the industry to recent rules (such as with respect to the "Basel Endgame" rules), combined with the Supreme Court's recent decision to dispose of Chevron deference,[21] have made the rulemaking process more demanding and subject to both internal and external challenges.
In the absence of a well-articulated regulatory need, we expect to see many comments and challenges to the NPRM. Such challenges are likely becoming the "norm," rather than the exception, by a newly emboldened financial services industry in the post-Chevron era. How the FDIC responds to these challenges will be a notable indicator of its view of its own rulemaking latitude, discretion, and independence in the coming years. The past agency practice of looking at something "closely enough" is likely to fade as scrutiny of agency action becomes more rigorous and less deferential.
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The FDIC has asked for the public to submit comments on the proposed rulemaking within 60 days after publication in the Federal Register. We will continue to track the industry's response to the proposed rulemaking and any developments from the FDIC and will report more on how insured depository institutions can come into compliance.
[1] 12 C.F.R. § 337.6(a)(2).
[2] 12 U.S.C. § 1831f.
[3] NPRM, at 3-13.
[4] 12 C.F.R. §§ 337.6(a)(5)(ii)-(iii).
[5] 12 C.F.R. § 337.6(a)(5)(v)(I).
[6] 12 C.F.R. § 337.6(a)(5)(v)(I)(1)(i).
[7] 12 C.F.R. § 337.6(a)(5)(v)(I)(1)(ii).
[8] Rob Nichols, "ABA Statement on Today's FDIC Board Meeting," American Bankers Association (July 30, 2024)
[9] "Remarks by Vice Chairman Travis Hill at the American Enterprise Institute 'Reflections on Bank Regulatory and Resolution Issues,'" Federal Deposit Insurance Corporation (July 24, 2024)
[10] See our previous posts analyzing the aftermath of the Supreme Court's decisions in Loper Bright v. Raimondo, SEC v. Jarkesy, and Corner Post, Inc. v. Board of Governors of the Federal Reserve System.
[11] Chamber of Com. of U.S. v. SEC, 85 F.4th 760, 777-79 (5th Cir. 2023).
[12] See Ohio v. EPA, 603 U.S. ___ (2024) (citing FCC v. Prometheus Radio Project, 592 U.S. 414, 423 (2021)).
[13] See "Cost Benefit Analysis Process for Rulemaking," FDIC Office of Inspector General, EVAL-20-003 (Feb. 2020). Significantly, the report found "that the FDIC's cost benefit analysis process was not consistent with widely recognized best practices identified by the OIG," and that the "FDIC was not transparent in its disclosure of cost benefit analyses to the public." Id., at 10. Moreover, other independent agencies have struggled with rulemaking when their cost benefit analyses were found inadequate. See, e.g., Bus. Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011); Chamber of Com. of U.S. v. SEC, 412 F.3d 133 (D.C. Cir. 2005).
[14] NPRM, at 6-7, 11-12.
[15] Supra note 8.
[16] See "Review of the Federal Reserve's Supervision and Regulation of Silicon Valley Bank," Board of Governors of the Federal Reserve System (Apr. 28, 2023)
[17] See "Material Loss Review of First Republic Bank," FDIC Office of Inspector General, EVAL-24-03 (Nov. 2023)
[18] NPRM, at 24, 51.
[19] Id., at 5.
[20] See id.,at 24.
[21] Supra note 10.
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