FDIC Proposes Overhaul to Brokered Deposit Classification Rules; Significant Impact to Banking as a Service (BaaS) Industry

On July 30, 2024, the Federal Deposit Insurance Corporation (FDIC) issued a proposed rule that would make significant revisions to the FDIC’s regulations implementing the provisions of Section 29 of the Federal Deposit Insurance Act (FDI Act) related to brokered deposits.

Key Highlights

The proposed rule would roll back many of the changes made by the FDIC to its brokered deposit regulations at the end of 2020. Among other proposed changes:

• A third party that has an exclusive relationship with a single insured depository institution could no longer cite exclusivity as a reason that it is not a deposit broker.
• Third parties that receive compensation in exchange for deposits being placed at an insured depository institution would be considered deposit brokers unless an exception applies.
• The enabling transactions exception would be eliminated.
• The 25 percent test exception would be significantly pared back and would only be available with respect to a broker-dealer or investment adviser that places less than 10% of the total assets it has under management for its customers at depository institutions.

What are Brokered Deposits?

Section 29 of the FDI Act does not define the term “brokered deposit,” but the FDIC’s regulations characterize a deposit as brokered if it is obtained, directly or indirectly, from or through the mediation or assistance of a deposit broker. A “deposit broker” generally includes any of the following persons: (i) any person that places or facilitates the placement of deposits with insured depository institutions, (ii) any person engaged in the business of placing deposits with insured depository institutions for the purpose of selling those deposits or interests in those deposits to third parties, and (iii) an agent or trustee who establishes a deposit account to facilitate a business arrangement with an insured depository institution to use the proceeds of the account to fund a prearranged loan. The FDI Act expressly excludes certain persons, including an agent or nominee whose primary purpose is not the placement of funds with depository institutions, from the definition of deposit broker.

The FDIC last made significant revisions to its brokered deposit regulations in 2020. These revisions provided (i) an exception from the definition of deposit broker for a person who places or facilitates the placement of deposits exclusively with a single insured depository institution, (ii) specific guidance on which activities constitute placing or facilitating the placement of deposits, and (iii) additional clarity on which types of business relationships are not conducted for the primary purpose of placing funds with insured depository institutions. The FDIC also implemented a prior notice or application process for certain designated business relationships that an insured depository institution or third party could utilize to take advantage of the primary purpose exception from the definition of deposit broker.

Why Brokered Deposits Matter

Section 29 of the FDI Act prohibits an insured depository institution that is less than “well capitalized” from accepting funds obtained, directly or indirectly, by or through any deposit broker for deposit into one or more deposit accounts. An institution that is adequately capitalized may apply for and obtain a waiver of this limitation from the FDIC on a case-by-case basis. Insured depository institutions prefer to avoid classifying deposits as brokered to mitigate the risk of potentially losing an important source of funding in the event the institution becomes less than well capitalized. Similarly, fintechs prefer that deposits not be considered brokered to mitigate potential operational impacts on their business and customers if an insured depository institution becomes less than well capitalized. The FDIC and other bank regulators expect institutions that accept brokered deposits to appropriately manage the liquidity and other risks related to brokered deposits—which are considered less “sticky” than other deposits—and discourage excessive reliance upon brokered deposits. High levels of brokered deposits can contribute to higher deposit insurance assessments.

Impact on BaaS Arrangements

If adopted as currently proposed, the new rule would significantly impact so-called “Banking as a Service” or “BaaS” arrangements through which banks offer and market their depository services to customers of a fintech or brand partner. Under the current rule, deposits generated through BaaS arrangements are typically not considered “brokered deposits” because it is possible to structure the arrangement so that the BaaS partner is not considered a deposit broker. The proposed rule would eliminate certain exceptions that banks and third parties have relied upon to structure these arrangements and, if adopted, would require banks to re-imagine the structure of their BaaS arrangements or treat deposits generated through such as arrangements as brokered. The proposed rule may also significantly limit a fintech’s or brand partner’s ability to be involved in meaningful ways with its own BaaS program.

Proposed Changes

The FDIC’s proposed rule, if adopted, would make the following significant revisions:

• Insured depository institutions could no longer rely upon exclusivity as a means of avoiding brokered deposit classification, as the definition of deposit broker would include a party who places or facilitates the placement of deposits at one or more insured depository institutions.
• A party that proposes or determines deposit allocations at one or more insured depository institutions would be considered a deposit broker. This prong of the definition of deposit broker would capture more activity than the “matchmaking” prong of the current rule, which is limited to proposing deposit allocations at, or between, more than one bank based upon both the particular deposit objectives of a specific depositor or depositor’s agent, and the particular deposit objectives of specific banks. The current rule provides an exception from the matchmaking prong for deposits placed by a depositor’s agent with a bank affiliated with the agent, but the proposed rule would eliminate that exception.
• Unless an exception applies, a third party would be considered a deposit broker if an insured depository institution or customer pays the third party a fee or provides other remuneration in exchange for deposits being placed at one or more insured depository institutions. The proposal does not explicitly rule out payment of compensation for bona fide services other than the placement of deposits, but it does not provide any clarity whether such fees may be permissible.
• The “enabling transactions” designated business exception would be eliminated. Under the current rule, subject to compliance with certain prior notification requirements, an agent or nominee is not considered a deposit broker with respect to a particular business line if all of the funds that the agent or nominee places, or assists in placing, at depository institutions are placed into transactional accounts that do not pay any fees, interest, or other remuneration to the depositor. The current rule permits an insured depository institution or third party to apply for permission from the FDIC to use this exception for placing funds into transaction accounts where fees, interest or other remuneration are provided to depositors, but this application process would no longer be available if the proposed rule is adopted.
• The current rule includes a “25 percent test” designated business exception under which an agent or nominee, subject to compliance with certain prior notice, quarterly reporting and annual certification requirements, is not considered a deposit broker if, with respect to a particular business line, less than 25% of the total assets that the agent or nominee has under administration for its customers is placed at depository institutions. As proposed, this exception would be limited to a broker-dealer or investment adviser that places less than 10% of the total assets it has under management for its customers at depository institutions if no additional third parties are involved in the deposit placement relationship. Assets would be considered to be under management if they consist of securities portfolios or cash balances with respect to which an investment adviser or broker dealer provides continuous and regular supervisory or management services. Only insured depository institutions—and not third parties—could give the required notice, and an institution could only rely upon the exception if the FDIC has not disapproved the notice within 90 days (unless the FDIC has extended the review period). An institution could apply to use the exception if a third party is involved in the arrangement. Institutions that rely on this designated business exception would be required to provide quarterly updates and to notify the FDIC if the business line that is subject to the notice no longer qualifies for the exception.
• The primary purpose exception would only be available with respect to an agent or nominee whose primary purpose in placing customer deposits at insured institutions is for a substantial purpose other than to provide a deposit placement service or obtain FDIC insurance.

The current rule provides that a third party is engaged in facilitating the placement of deposits if the third party, while engaged in business, with respect to deposits placed at more than one insured depository institution, engages in activities in which the third party:

• has legal authority, contractual or otherwise, to close a deposit account or move a third party’s funds to another insured depository institution;
• is involved in negotiating or setting rates, fees, terms, or conditions for the deposit account; or
• engages in matchmaking activities (as defined in the FDIC’s rules).

Notably, as under the current rule, a third party that does not have legal authority, contractual or otherwise, to close a deposit account or move a third party’s funds to another insured depository institution and that is not involved in negotiating or setting rates, fees, terms, or conditions for the deposit account should not be considered a deposit broker if the party does not otherwise engage in activities that would cause it to be a deposit broker.

Reciprocal Deposits

The proposed rule would also make certain changes related to reciprocal deposits. In 2018, Section 29 of the FDI Act was amended as part of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), to allow an “agent institution” to exclude a capped amount of reciprocal deposits from treatment as brokered deposits. An institution qualifies as an agent institution if it (i) is well capitalized under the Prompt Corrective Action rules and has a CAMELS composite condition of outstanding or good, (ii) is adequately capitalized and has obtained a brokered deposit waiver from the FDIC, or (iii) does not receive an amount of reciprocal deposits that causes the total amount of reciprocal deposits held by the agent institution to be greater than the average of the total amount of reciprocal deposits held by the agent institution on the last day of each of the four calendar quarters preceding the calendar quarter in which the agent institution was found not to have a composite condition of outstanding or good or was determined to be not well capitalized (the special cap).

EGRRCPA and the FDIC’s implementing regulations do not address how an insured depository institution that is no longer an agent institution may subsequently requalify as such. The proposed rule provides that an insured depository institution may regain its “agent status” as follows:

• If the insured depository institution is well capitalized, when the institution is notified that its CAMELS composite condition is rated outstanding or good at its most recent examination;
• If the insured depository institution is well-rated, when the institution is notified, or is deemed to have notice, that it is well capitalized under Prompt Corrective Action rules;
• If FDIC grants a brokered deposit waiver; or
• On the last day of the third consecutive calendar quarter during which the institution did not at any time receive reciprocal deposits that caused its total reciprocal deposits to exceed its special cap.

Comments

Comments on the proposed rule are due within 60 days after publication in the Federal Register (which has not yet occurred). If you have questions about how the proposed rule may affect a particular BaaS or other arrangement involving an insured depository institution or would like to comment on the proposed rule, please do not hesitate to reach out to your Goodwin contact or any of the authors of this client alert.

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.