How Reciprocal Deposits Build Franchise Value


deposits-1-16-19.pngThere are many alternatives to core deposits that banks can utilize to fund loans. Internet listing services, for example, have become popular. Unlike brokered deposits, there are no regulatory deterrents against their use. Still, internet listing-service deposits tend to be more expensive and more price sensitive—hence less stable—than traditional core deposits because they often come from out-of-market customers who chase rates rather than from local customers looking to establish a relationship.

Banks have another important, and arguably better, deposit-gathering tool at their disposal—reciprocal deposits. Thanks to the Economic Growth, Regulatory Relief and Consumer Protection Act, most reciprocal deposits now receive nonbrokered status.

What are reciprocal deposits? These are funds received by a bank through a deposit placement network in return for placing a matching amount of deposits at other network banks. Why would banks exchange equal amounts of money with each other? The mechanics of different reciprocal deposit services vary, but the gist is that a bank that participates in a reciprocal deposit network can offer access to FDIC insurance beyond $250,000 to attract safety-conscious customers who might otherwise consider various alternatives, including:
Depositing large sums into a money-center bank, foregoing some access to FDIC insurance and perhaps relying on ratings agencies, like Standard & Poor’s or Fitch, to help assess bank stability
Requiring that a bank collateralize or otherwise secure a large deposit with Treasuries or other ultra-safe, highly liquid government securities
Manually splitting a large deposit among multiple banks, maintaining relationships with each and negotiating different interest rates, signing multiple agreements and receiving multiple statements

Banks that participate in a reciprocal deposit network like the ability to more effectively pursue these large-dollar deposits from local customers who were previously beyond their reach, or whose collateralization requirements raised tracking and opportunity costs and lowered margins. Banks like that they can take multi-million-dollar deposits and place them through a reciprocal deposit network into other banks participating in the same network in increments below $250,000. The spreading out of the funds into multiple banks makes the entire amount eligible for FDIC insurance. This process enables a customer to access FDIC protection from many banks while working directly with just one. And the originating bank maintains ownership of the customer relationship.

Banks that receive reciprocal deposits from another bank are willing to take those funds because they are doing the same thing with their customers’ money. All told, participating banks exchange funds on a dollar-for-dollar basis so each comes out whole—giving rise to the term reciprocal deposits.

“Reciprocal deposits are popular because they tend to be associated with multi-million-dollar depositors, enabling banks to attract deposits in large chunks with lower acquisition and maintenance costs as costs tend to be spread over much larger deposit amounts,” explains Mark Thompson, president of CenterState Bank in Davenport, Florida. “Moreover, they tend to come from local customers at rates that are more in line with local pricing norms. They also tend to come from customers who are more likely to be interested in a broader, more long-term relationship that may include mortgages, credit cards and other profit-generating services.”

“In stark contrast to listing-service deposits, reciprocal deposits help a bank build franchise value,” according to James Di Misa, executive vice president and chief operating officer of Community Bank of the Chesapeake in Waldorf, Maryland. “Quite simply, reciprocal deposits tend to be large, lower-cost, in-market deposits and, as such, offer greater potential for opportunity and efficiency. For this reason, many banks are replacing at least a portion of their listing-service deposits with reciprocal deposits.”

Banks that don’t want to trade out listing-service deposits entirely can still use reciprocal deposits to augment their usage of listing-service funding. For example, they can use a reciprocal deposit offering to lure more business from a safety-conscious listing-service customer who keeps funds protected at multiple FDIC-insured institutions and who might consolidate some, or all, of their deposits with a bank that can offer access to FDIC protection far beyond $250,000.

And of course, reciprocal deposits can be a good replacement for collateralized deposits and wholesale funding options.

As the competition for deposits heats up, now is a good time for every bank to consider making reciprocal deposits a larger part of its funding strategy.

To learn more, please visit www.promnetwork.com/game-changer.

Relief for Community Banks in the Competition for Deposits


deposits-10-22-18.pngThe recent bank reform bill made a lot of news, but what may surprise you is the specific provision of the Economic Growth, Regulatory Relief, and Consumer Protection Act that community bankers believe will have the biggest impact on their daily business.

Before the bill became law, a lot of attention was placed on the provision raising the systemically important financial institutions, or SIFI, threshold from $50 billion to $250 billion in assets, above which banks must contend with a heavier compliance burden.

Yet, the provision involving SIFIs directly impacts only a small number of commercial banks based in the United States—the dozen-plus with between $50 billion and $250 billion in assets.

Perhaps that’s why when Promontory Interfinancial Network queried bankers for its second-quarter Executive Business Outlook Survey, executives from the 390 banks that responded pointed elsewhere when asked to identify the law’s most impactful provision.

Thirty-seven percent of respondents said the law’s provision that allows most reciprocal deposits to be treated as nonbrokered deposits ranked highest on a scale of one to five, placing it first among the seven other provisions tested.

It was up against stiff competition. The other provisions included those that eased the qualified mortgage rule, extended the regulatory exam cycle and simplified capital rules for community banks, among others.

“We think the change to reciprocal deposits is great,” says Christopher Cole, executive vice president and senior regulatory counsel for the Independent Community Bankers of America. “It clarifies the status of reciprocal deposits and alleviates the concerns many community banks had about using them.”

Similarly, the American Bankers Association noted that, “the definition of brokered deposits needs to be modernized and we appreciate that Congress took a first step by recognizing reciprocal deposits are a stable source of funding for many community banks.”

The change in the law makes sense, says Neil Stanley, president of community banking at TS Banking Group, which owns three banks, including Treynor State Bank, a $400 million bank based in Treynor, Iowa: “This is one of those areas that reflects what bankers always thought was true—when a large, local depositor does business with us, any deposits above the $250,000 FDIC insurance threshold shouldn’t be considered brokered or highly volatile just because we place them with other institutions on a reciprocal basis.”

Underscoring the significance of the change, 58 percent of respondents to Promontory Interfinancial Network’s survey said they plan to start using, or expanding their use of, reciprocal deposits immediately or very soon because of the new law. An additional 29 percent said they would consider doing so in the future.

To put this in perspective, according to the same bank leaders, the next most impactful provision included in the new law relates to the easing of rules surrounding commercial real estate loans, followed by the provision that shortened call reports and then by the provision that provided qualified mortgage relief.

The change in reciprocal deposits may seem like a peripheral issue, but it addresses a fundamental inequity in banking. It does so by helping to level the playing field between the handful of large, money center banks headquartered in places like New York City and the thousands of smaller banks spread across the country that serve as economic lifelines in their communities.

Institutional investors have often favored big banks because of the belief they are “too big to fail.” And since they have more resources to invest in mobile and online banking technology, big banks have become magnets for deposits from the new generation of digitally savvy consumers. These banks no longer need to rely as heavily on building branches in rural communities to compete with community banks for funding; they can now reach small-town customers through their smartphones.

As such, many of the nation’s biggest banks are reporting organic increases in deposits. And the competition on the funding side of the balance sheet will only intensify as interest rates climb. The Federal Reserve’s Open Market Committee has raised the fed funds rate multiple times this year and is expected to continue doing so.

By making it easier for community banks to use reciprocal deposits, in turn, the new law strengthens their ability to grow relationships and deposits from a local customer base without losing either one to bigger banks with deeper pockets.

“This is a step in the right direction,” says Bert Ely, a principal of Ely & Company, where he monitors conditions in the banking industry. “It makes it easier for community banks to accommodate large depositors.”

Given all this interest, it seems likely that the use of reciprocal deposits will increase in the coming months and years. Banks not currently familiar with them would thereby be wise to familiarize themselves with how reciprocal deposits work and their benefits.

If you are interested in reading the full bank survey report, visit here. To learn more about reciprocal deposits and the impact of the new law, go to promnetwork.com.