The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018: A Game Changer for Banks and Local Communities
Courtesy of Promontory Interfinancial Network
On May 24, 2018, President Donald Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act, which provides relief from certain rules and regulations for community banks. Among the law’s many provisions, one stands out in importance—most reciprocal deposits are no longer considered “brokered deposits.”
This change benefits banks and local communities across the United States in a number of ways. In particular, it helps Main Street banks to attract and retain a greater amount of deposits that behave like core deposits from local customers by
- expanding the availability of deposit funding for such banks;
- providing banks with more funding to make loans available within their communities;
- potentially lowering the cost of funding for banks over time; and
- enabling such banks to help customers safeguard deposits above $250,000 and compete for stable funding.
What Reciprocal Deposits Are and Why They Matter
In the past, many large-dollar depositors, such as public entities, institutional investors, and nonprofits, were reluctant to deposit their cash at small banks because their deposits could only be insured up to $250,000; they feared losing money if their bank failed. In effect, small banks were often penalized for their size on the mistaken belief that small automatically equalled risky. This changed in the fall of 2002 when Promontory Interfinancial Network began offering the first “reciprocal deposit” placement service—CDARS® and, later, another one called Insured Cash Sweep®, or ICS®.
Reciprocal deposits are deposits that a bank receives through a deposit placement network in return for placing a matching amount of deposits at other network banks.1
Although there are a number of providers, the leading reciprocal deposit placement service in the United States is operated by Promontory Interfinancial Network, LLC, which invented reciprocal deposits and offers two of the nation’s largest reciprocal deposit placement services mentioned above, ICS and CDARS.
Nationwide, thousands of banks use these services to provide safety-conscious customers with access to FDIC insurance beyond the traditional $250,000 per insured bank, per depositor (technically, for each account ownership category). The Insured Cash Sweep service provides access to FDIC insurance on funds placed into demand deposit accounts and money market deposit accounts, whereas the CDARS service provides that access on funds placed into CDs. The safety-conscious customer is often a government organization (such as a city or county treasurer or a public school district), an institutional investor, a nonprofit, or another depositor that would otherwise
- make a large deposit in a large money-center bank, rather than a community bank (foregoing access to FDIC insurance for most of the deposit and relying on large rating agencies, like Standard & Poor’s and Fitch, and then tracking the ratings over time);
- require that a bank collateralize or otherwise secure the deposit with Treasuries or other ultra-safe, highly liquid government securities (an added cost for the bank and one that could lead to the customer receiving a lower interest rate if the bank adjusts its rate to compensate for the added cost it incurs); or
- manually split its large deposit among multiple banks, maintaining relationships with each (which requires negotiating different interest rates, signing multiple agreements, receiving multiple statements, etc.).
Insured Cash Sweep and CDARS are popular services because they enable safetyconscious customers to access multi-million-dollar FDIC insurance through a single bank relationship. Bank customers enjoy peace of mind and the convenience of working though one institution. Participating banks enjoy the ability to grow relationships and deposits from a local customer base without losing either to larger, too-big-to-fail institutions; without the added costs or tracking burdens associated with ongoing collateralization requirements; and with the ability to turn around and lend these relatively low-cost funds locally. At the end of the day, it’s a win-win for banks and their customers. But how this all comes together matters.
How Services Like Insured Cash Sweep and CDARS Work
The mechanics of different reciprocal deposit services vary. With Insured Cash Sweep and CDARS, a participating bank can offer access to FDIC insurance beyond $250,000 because its customer’s original deposit can be split into smaller increments—each below the standard FDIC insurance maximum—and placed into deposit accounts at a large number of other banks.
This process enables a customer to access coverage from many banks while working directly with just one (and, generally, receiving just one regular statement per service).
Bank-to-Bank Connections – Helping Community Banks Help Each Other
So why would a bank agree to take Insured Cash Sweep or CDARS deposits from another bank, essentially helping that other bank? Because in a reciprocal service, it is doing the same thing with its customers and sending an equal amount of customer deposits to other banks (generally with help from a sophisticated matching engine that connects participating banks with each other based on different variables, such as the total amount of a customer’s deposit). Exchanges occur on a dollar-for-dollar basis so that each participating bank comes out whole. In other words, each participating bank reciprocates—thus, the term reciprocal deposits.
The Economic Growth, Regulatory Relief, and Consumer Protection Act
This Act recognizes something that many in the banking sector have long understood: reciprocal deposits behave like core deposits; they are “sticky” (CDARS reinvestment rates are approximately 80 percent), and the institution accepting the deposit maintains a relationship with the depositor—almost always a locally based depositor.2
The new law acknowledges that reciprocal deposits are uniquely different from brokered deposits.
Specifically, the law amends Section 29 of the Federal Deposit Insurance Act so that reciprocal deposits held by an FDIC-insured depository institution are not be considered brokered deposits as long as:
- The bank is well capitalized and has received an “outstanding” or “good” on its most recent examination; and
- The total amount of reciprocal deposits held does not exceed the lesser of $5 billion or 20% of the bank’s total liabilities.
In addition, a bank that drops below well capitalized can continue to accept reciprocal deposits without a waiver from the FDIC, so long as it does not receive an amount of reciprocal deposits that causes its total reciprocal deposits to exceed a previous four quarter average.3
These changes have positive implications for the banking sector. Banks now have a much larger, approved source of stable deposits that can be tapped.
Furthermore, banks will be able to replace more expensive deposits, like brokered deposits, routinely collateralized deposits, and those from listing services (generally associated with wholesale pricing and no loyal or local customer relationship), with reciprocal deposits, like those available using CDARS and Insured Cash Sweep. These are generally lower-cost deposits that are eligible for multi-million-dollar FDIC insurance and that come from local customers at rates that banks set.
Bank customers will also benefit in a number of ways from this change in law. Banks can help even more customers—including businesses (large and small), nonprofits, municipalities, financial advisors, and even individuals—to safeguard their funds, potentially at even higher levels, while at the same time attracting locally priced, largedollar deposits, the full amount of which can be used to make loans locally. This helps communities across the United States.
Of note, the ability to offer reciprocal deposits can be critically important to banks located in disadvantaged/underserved communities. These banks tend to rely more heavily on the ability to offer large-dollar access to FDIC insurance to attract deposits from socially responsible investors. Deposits from these investors are then used to fund local lending initiatives (e.g., infrastructure improvements, low-income housing, education, and other important activities) that otherwise might not take place.
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1. Most state laws expressly permit the use of reciprocal deposits by public entities, and they define reciprocal deposits in similar ways, generally adding that the maturities, if any, of the deposits placed and received, as well as the amounts, must match.
2. Through 2/28/18. Promontory Interfinancial Network calculates the reinvestment rate by determining whether a particular customer’s funds were reinvested within 28 days of maturity.
3. As under current law, interest rate restrictions will apply.