FDIC finishes long-awaited rules on brokered funds, ILCs

WASHINGTON — Banks and some of their deposit-gathering businesses won additional regulatory relief Tuesday when the Federal Deposit Insurance Corp. finalized a new framework for classifying brokered deposits enabling a broader set of companies to escape restrictions.

The final overhaul roughly tracks with a December 2019 proposal aim at modernizing the definition of brokered deposits for the digital age. That definition has huge ramifications; banks with capital levels below the “well capitalized” mark are barred from accepting brokered funds.

At a public meeting, the agency’s board of directors also finalized long-awaited standards for the corporate parents of industrial loan companies. Nonbanks such as fintech firms have sought greater clarity on the process for seeking ILC charters, while community banks have opposed many high-profile ILC charter bids.

But revamping the brokered deposit classification drew greater interest. In the final rule, the agency went further compared to the proposal in providing relief in key areas. For example, the final rule removed certain provisions that banks complained could apply the brokered deposits definition too broadly, including a definition of “deposit broker” that would rely on whether such entities shared information with banks.

The rule, which will fully go into effect in 2022, also codifies some past advisory opinions exempting certain firms from the “broker” label, meaning such opinions could potentially be applied more broadly, but the agency signaled that many of those opinions will not match the new framework and therefore will be eliminated.

The FDIC board approved both the brokered deposit and ILC rules by a vote of 3-1, with former FDIC Chairman Martin Gruenberg dissenting.

Bloomberg News

Yet the core of the rule remains the same as the proposal, which narrowed the FDIC’s definition of deposit brokers and introduced a new exemption application process built around the statute’s “primary purpose” clause.

The FDIC board approved both the brokered deposit and ILC rules by a vote of 3-1, with former FDIC Chairman Martin Gruenberg dissenting.

The other members of the board hailed the brokered deposit overhaul, saying it reflects the reality of the industry’s continued digital transformation.

“The rule modernizes the concept of brokered deposits in a way that supports consumer choice and access to financial services by supporting responsible fintech-bank partnerships,” said acting Comptroller of the Currency Brian Brooks, who sits on the FDIC board.

Yet officials and industry representatives called on Congress to make other necessary changes.

“Today marks the culmination of this multiyear effort,” FDIC Chair Jelena McWilliams said. But she also repeated her long-running request for Congress to consider replacing Section 29 of the Federal Deposit Insurance Act, which requires the agency to restrict brokered deposits.

“I would like to reiterate the challenges associated with implementing the brokered deposits statute,” McWilliams said. “Creating a broadly applicable rule for every type of deposit arrangement involving a third party is an enormous challenge, and new products will continue to arise that challenge any framework attempting to do so.”

In a statement, American Bankers Association President and CEO Rob Nichols commended the FDIC but echoed the call for Congress to do away with Section 29.

“Today’s final FDIC rule is an important step that recognizes that markets have evolved, and new technologies have changed the ways banks gather deposits and the ways bank customers access and manage their funds,” Nichols said. “We thank FDIC Chairman McWilliams for her leadership on this critical issue and echo her call for Congress to revisit Section 29 of the FDI Act, and to consider whether it still achieves the policy goals it was enacted to accomplish.”

But Gruenberg said the final regulation would “make significant changes to the [proposed rule] that would dramatically further weaken the prudential protections of the current rule.”

He also appeared to criticize the timing of the board’s consideration of the rule, saying a final draft of the 177-page regulation was not given to members of the board until just hours before the meeting.

“As a procedural issue, a draft of this complex and significant rulemaking was not available to members of the board until last Wednesday, and a complete draft was not available until Saturday,” Gruenberg said. “The board did not receive the actual final rule until shortly before midnight last night.”

Under the final rule, the FDIC provides three core criteria for determining whether an entity is a deposit broker.

The first examines the legal authority of an entity to move deposits between banks. The second considers whether the entity is involved in setting the “rates, fees, terms, or conditions” of a given deposit account at a bank, according to an FDIC staff memo.

The third criteria looks at whether the entity is engaging in a “matchmaking service,” in which banks and the depositors are pursuing common objectives.

In the final rule, the FDIC also removed a section from last year’s proposal that would have labeled entities involved in the “direct or indirect sharing of information” as deposit brokers. In the staff memo, the FDIC said it agreed with commentators who claimed the previous criteria was “overly broad.”

The final rule also includes a new provision tied to “exclusive” deposit arrangements between banks and other entities. The FDIC said in a staff memo that it recognized “a number of entities, including some financial technology companies, partner with one insured depository institution to establish exclusive deposit placement arrangements,” and that those deposits were “less likely to move” in a way that would make them unstable.

The FDIC introduced several new categories for the “primary purpose” exemption, which would apply when the main function of a potential deposit broker’s relationship or business line with a bank isn’t the placement of deposits. Those include cases when less than 25% of a broker’s assets are placed at depository institutions, as well as when “all customer deposits placed at depository institutions are placed into transaction accounts and no fees, interest or remuneration are being paid to the depositor.”

The rule is somewhat of a mixed bag for firms that worried the agency would throw out decades of advisory opinions that applied to individual deposit-gathering models.

While “the content of some of the opinions have been included in this final rule,” other “previous staff advisory opinions will be moved to inactive status on the FDIC’s website” after the full compliance date of Jan. 1, 2022.

In tandem with its overhaul of the brokered deposit definition, the FDIC also finalized changes to the way it calculates the national rate cap, which acts as a kind of interest rate ceiling for banks that are less than well capitalized.

Generally, an undercapitalized bank cannot offer deposit rates more than 75 basis points above the national rate. Under the final rule, the FDIC is replacing its current simple average methodology with one of two approaches, depending on which is higher: an average weighted by the deposit rates of both banks and credit unions plus 75 basis points, or 120% the current yield of similar maturity U.S. Treasuries plus 75 basis points.

Rules for industrial bank parents

Meanwhile, the FDIC board also approved a final rule establishing certain conditions and supervisory standards for the parent companies of industrial banks and ILCs. The rule was largely identical to a March 31 proposal.

“The rule would provide transparency to market participants regarding the FDIC’s minimum expectations for parent companies of industrial banks,” McWilliams said. “In addition, the rule would ensure that all parent companies of industrial banks approved for deposit insurance going forward would be subject to these commitments.”

The industrial bank charter has endured years of controversy and opposition from mainstream banks because the charter is legally available to nontraditional bank owners such as fintechs and retailers. They can use it to accept FDIC-insured deposits and offer other banking services without being supervised by the Federal Reserve as a consolidated bank holding company.

FDIC approvals for ILC charters were essentially halted for more than a decade following a policy battle over Walmart’s unsuccessful attempt to open a bank. Yet the legal framework for industrial banks is largely unchanged, and approvals lately have picked up — including for the leading payments fintech Square.

The FDIC rule is meant to ensure parent companies serve as a source of strength for the industrial bank, and to provide transparency to applicants about what the agency expects of them.

The rule codifies a requirement that ILC parents enter into a written agreement with the FDIC on capital and liquidity levels, and enables the agency to require additional commitments related to the proposed bank’s business model.

The proposal laid out commitments and conditions for an ILC applicant to get approval for deposit insurance as well as a change in control. The commitments included consent for the FDIC to examine the parent company, the submission of an annual report on the covered company and each subsidiary, and a pledge to “maintain the industrial bank’s capital and liquidity at such levels as the FDIC deems necessary for the safe and sound operation of the industrial bank.”

In the final rule, the FDIC tweaked the proposal by adding a requirement for covered companies to inform the FDIC about how it aims to protect the security and confidentiality of a consumer’s personal information.

Under the proposal, a parent company’s representation on the board of the industrial bank was capped at 25%, but the final rule raised that limit to 50%. The rule also provides some flexibility for an ILC subsidiary to appoint directors and senior executives in a more timely fashion after a three-year period.

Joe Adler contributed to this article.


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