For a long time, it seemed as if the deck was stacked against community banks. Since the financial crisis, the nation’s largest banks have gobbled up some $2.4 trillion in new deposits. Big banks have deep pockets to spend on technology—money that smaller banks don’t have. And because of their concerns about safety, customers with more than $250,000 to deposit often shy away from community banks, thinking they are risky places to park deposits given the potential for a bank failure.
But now, some of that imbalance has shifted in favor of community banks. In May, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act. One of many bank-friendly aspects of the new law is a change in treatment of most reciprocal deposits. (Reciprocal deposits are deposits that banks place through a deposit placement network in exchange for matching deposits. Exchanging deposits on a dollar-for-dollar basis via a deposit placement network enables participating banks to provide their customers with access to FDIC insurance beyond $250,000.) Subject to certain restrictions, most reciprocal deposits are now considered nonbrokered. In enacting this change, Congress and the president have essentially acknowledged that most reciprocal deposits tend to behave like other deposits that come from locally based customers, and therefore, are a more stable source of funds than traditional brokered deposits.
Thanks to the new law, a well-capitalized bank with a CAMELS rating of 1 or 2 can hold reciprocal deposits up to the lesser of 20 percent of its total liabilities, or $5 billion, without those deposits being treated as brokered. (Reciprocal deposits over these amounts are treated as brokered.) Further, a bank that drops below well-capitalized status no longer requires a waiver from the Federal Deposit Insurance Corp. to continue accepting reciprocal deposits so long as it does not receive an amount of reciprocal deposits that causes its reciprocal deposits to exceed a previous four-quarter average.
The change in classification is pivotal for many banks. Here’s why:
- Banks can seek out more large-dollar, safety-conscious customers—business they may not have attracted before, particularly if they’re a smaller community bank competing with a bank that is perceived as “too-big-to-fail.” Many business and nonprofit customers fall into this bucket.
- Additionally, community banks can pursue more government and financial institution deposits as the nation’s largest banks—which are subject to liquidity coverage ratio calculations—look to shed these deposits. This will provide an opening for community banks to win these large-dollar deposits and to go after the whole banking relationship.
- But that’s not all. Banks can also do more to replace or reduce their reliance on:
- Collateralized deposits, which can be associated with significant opportunity costs, since they require banks to invest funds in U.S. Treasuries or other securities that might otherwise be used to fund loans that generate higher returns, and require additional cash outlays for such things as tracking securities.
- Deposits that come through internet listing services. Such deposits don’t build franchise value the way reciprocal deposits do, and they tend to come from more rate-sensitive customers, not to mention out-of-state or out-of-market customers—who tend to be less loyal.
- Higher-priced wholesale funding.
- Finally, community banks can use reciprocal deposits to lock in more low-cost funding as a hedge against higher rates in the future—to take advantage of low deposit betas for services like Insured Cash Sweep® and CDARS®, and to secure customers for longer terms through, for example, a CD offering like CDARS.
Each of these can have a significant, positive impact on the bottom line and on return-on-assets and return-on-equity ratios. And each of these is something that banks can do more of now. Bottom line: With the new law, reciprocal deposits have become even more attractive for well-capitalized banks to use so that they can have more funds on hand and can make more loans.
Funding may still be a challenge for community banks in an environment of increased deposit competition. But thanks to the new law, community banks will at least have greater access to a tool to that can make their jobs easier.