Subprime mortgages, greedy big banks and brokered deposits were at the root of the 2007 financial crisis, or so goes the case of federal regulators who helped saddle institutions big and small with Dodd- Frank.
But a recent study by a former bank regulator and respected scholar, James R. Barth and a doctoral student Yanfei Sun, both from my alma mater, Auburn University, has sacked part of the regulators’ premise, the slice that gave brokered deposits a black eye.
As you know, brokered deposits generally involve a third party to assist in placement and may be used by your bank to diversify funding.
Barth and Sun conducted an exhaustive study of the impact and risk of reliance on brokered deposits for the Utah Center for Financial Services, and “found no direct causal relationship between brokered deposits and bank failures.” Read the entire study and summaries HERE.
The two scholars closely examined 59 studies to determine the impact of brokered deposits not only on the Great Recession of the early 21st century, but on other economic crises as well.
Barth and Sun found that brokered deposits “are now a well-understood and accepted source of funds that help banks innovate business models and offer convenience and return for customers. These deposits help diversify funding and add to the soundness of well-run institutions,” according to a university press release announcing the study and its findings.
Barth contends that the FDIC should update its policies regarding these deposits, while recognizing the stability and accessibility of the funding, as well as lower costs, according to the release.
The study is among the latest salvos in an ongoing debate over brokered deposits. But I can speak to the impact of the FDIC’s heavy-handed regulation of third-party deposits, which started with the 2007 crisis when regulators mandated that banks “write down” their real estate loans and put the kibosh on brokered deposits.
Banks were paying less for brokered deposits than they were for local deposits. The FDIC thought that brokered deposits were riskier, fearing that they would not be renewed and would leave the bank faster than local deposits.
But this study, as well as other research, reveals that brokered deposits did not contribute to bank failures. In fact, the FDIC itself bears a portion of the blame because of its announcements concerning problem banks that helped trigger Great Depression-style bank runs.
The Barth Sun study raises some critical questions:
First, why can’t banks go directly to customers anywhere in the country to get lower-priced money? And why should a bank in Atlanta have to pay 2 percent for a one-year certificate of deposit, when they could pay half that for money in another city or state? As we know, one percent is huge in the banking industry.
Bankrate.com, a well-known financial website that tracks CD rates, states “The best one-year CD rates pay almost four times the national average of 0.59 percent APY”. This is based on their recent national survey of banks and thrifts.” See https://www.bankrate.com/banking.cds/best-1-year-cd-rates/
A well-run bank knows the date that loans need to be funded. Why not wait until close to that date to get the deposits? There’s no reason to be paying high CD rates for money that is just sitting around gathering dust.
Consider this from a September 2017 opinion piece for American Banker by Jeff W. Dick, a former national bank examiner with the Office of the Comptroller of the Currency. He is currently the Chairman and CEO of MainStreet Bank, a community bank in northern Virginia.
He offered a bit of historical perspective on why there is a stigma on wholesale deposits, and why regulators still hold fast to that wrongheaded notion.
A 1988 study on failed institutions by the Office of the Comptroller of the Currency revealed that more banks failed in the 1980’s than in the whole prior post-Depression era, failures initially pinned on sagging local economies. However, in a nutshell, the OCC determined that “bad management and weak corporate governance” begat bad banks.
“Bad banks were ill-equipped to manage the liability (deposit) side of their balance sheets and bad banks turned to “brokered” deposits. Therefore, the logic went, brokered deposits were bad for banks,” Dick wrote.
He pointed out that 30 years later, the stigma remains, despite a vastly different banking landscape
Now, to use brokered deposits, banks must be well-capitalized. Brokered deposits and other similar sources have stringent financial requirements to ensure only high-quality institutions can access their services.
“What was once considered to be a depositor of ‘last resort’ has moved to the top of the class,” Dick wrote. “Wholesale deposits have matured . . . During the most recent financial crisis, regulators thought they found a correlation between the faster growing banks that made bad loans and those that used wholesale deposits. However, this is correlation without causation and therefore is not relevant. Any bank would have made the same bad lending decisions if it had sourced local deposits instead of wholesale deposits.” Read the entire article HERE:
Dick added:” The regulators were loath to prove a cause and effect that simply didn’t exist.”
“ . . .[R]egulators are still painting listed deposits, wholesale deposits, brokered deposits and so on all with the same broad brush – claiming they are not as reliable as funding provided by a customer walking through the door. An unbiased study would likely prove that the opposite is actually true.”
Thanks to James Barth and Yanfei Sun, that unbiased study is here.
It’s time for regulators to remove the stigma and move out of a decades-old mindset that has handcuffed community banks.
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Here’s another article written two years ago about the FDIC. I think you’ll find it interesting: