Rethinking deposit insurance on brokered deposits

We’re sorry, something doesn't seem to be working properly.

Please try refreshing the page. If that doesn't work, please contact support so we can address the problem.

Abstract

In a bid to understand how the Federal Deposit Insurance Corporation (FDIC) can aid in promoting financial stability, economists have recently called the definition of core deposits into question. Deposit insurance is extended to core deposits because they represent the stable funding base that the banking system relies on for liquidity. The criteria used by the FDIC to determine whether a funding source is insurable are not consistent with any objective criteria available to define core deposits. Herein I assess current FDIC criteria and whether the kinds of deposits currently insured are good candidates for coverage. I find brokered deposits to be particularly ill-suited to insurance. The FDIC could further promote banking-system stability while simultaneously reducing potential costs by ending its extension of insurance to brokered deposits.

This is a preview of subscription content, log in to check access.

Figure 1
Figure 2

References

  1. 12 U.S.C. section 1828(a)(1)(B).

  2. See 49 Fed. Reg. 13003 (2 April 1984) (effective on 1 October 1984).

  3. See FAIC Securities, Inc. versus United States, 768 F.2d 352 (D.C. Cir. 1985).

  4. Committee on Banking, Finance and Urban Affairs, 1985. Impact of brokered deposits on banks and thrifts: Risks versus benefits (hearing before the Subcommittee on General Oversight and Investigations of the Committee on Banking, Finance, and Urban Affairs, House of Representatives, Ninety-ninth Congress, first session), 16 July.

  5. Pub.L. 101–73, 103 Stat. 183.

  6. X12 C.F.R. § 337.6. cf. Dreyfus, J., Saunders, A. and Allan, L. (1994) Deposit insurance and regulatory forbearance: Are caps on insured deposits optimal? Journal of Money, Credit and Banking 26(3), part 1: 412–438.

  7. The capital measure terms are defined in the following regulations: FDIC – 12 C.F.R. Part 325, Subpart B; Board of Governors of the Federal Reserve System – 12 C.F.R. Part 208; Office of the Comptroller of the Currency – 12 C.F.R. Part 6; Office of Thrift Supervision – 12 C.F.R. Part 565.

  8. Pub.L. 111–203, H.R. 4173.

  9. Federal Deposit Insurance Corporation (FDIC) (2011) Study on core deposits and brokered deposits, http://www.fdic.gov/regulations/reform/coredeposit-study.pdf, accessed 28 June 2013.

  10. Pub.L. 111–203, H.R. 4173, sec. 1506(a)(1).

  11. Pub.L. 111–203, H.R. 4173, sec. 1506(a)(4).

  12. See FDI Act, 12 U.S.C. 5 1821(f).

  13. Federal Register (2013) Deposit insurance regulations; definition of insured deposit, proposed rules, 78 (33), pp. 11604-11609, http://www.federalregister.gov/articles/2013/02/19/2013-03578/deposit-insurance-regulations-definition-of-insured-deposit, accessed 28 June 2013.

  14. Note that this problem is not apparent in full-reserve banking systems, as advocated in Huerta de Soto (2006: Chapter 9) and Bagus and Howden (2013; forthcoming). Kotlikoff (2010) provides a similar proposal by advocating that a full reserve be held in the form of highly liquid debt securities, such as government bonds. See Huerta de Soto, J. (2006) Money, Bank Credit and Economic Cycles, trans. M.A. Stroup. Auburn, AL: Ludwig von Mises Institute; Bagus, P. and Howden, D. (2013) Some ethical dilemmas with modern banking. Business Ethics: A European Review 22(3): 235–245; Bagus, P. and Howden, D. (forthcoming) The economic and legal significance of ‘full’ deposit availability. European Journal of Law and Economics; Kotlikoff, L.J. (2010) Jimmy Stewart is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking. New York: Wiley.

  15. Diamond, D.W. and Dybvig, P.H. (1983) Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91 (3): 401–419.

    Article  Google Scholar 

  16. Historical alternatives to dealing with the common bank run without insurance exist – including the suspension of convertibility of deposited funds, clearinghouse loans to finance short-term illiquidity and banks cross-guaranteeing each others’ deposit bases. See: Selgin, G. and White, L.H. (1997) The option clause in Scottish banking. Journal of Money, Banking and Credit 29(2): 270–273; Timberlake Jr., R.H. (1984) The central banking role of clearinghouse associations. Journal of Money, Credit and Banking 16(1): 1–15; Calomiris, C.W. (1989) Deposit insurance: Lessons from the record, Economic Perspectives, Federal Reserve Bank of Chicago, 13 (May–June) pp. 10–30; Hartley, J.E. (2001) Mutual deposit insurance: Other lessons from the record. Independent Review 6(2): 235–252.

  17. While the literature more commonly focuses on increased risk taking by bankers as the consequence of the moral hazard of deposit insurance, Ely (1999) looks at ‘regulatory moral hazard’. Any deposit-insurance fee will be paid by solvent banks, which are also not able to easily avoid paying such fees. As a consequence, regulatory diligence will have a tendency to decrease, because it will always be paid by surviving banks, which effectively cover losses from bank insolvencies caused by lax regulatory policies. Ely, B. (1999) Regulatory moral hazard: The real moral hazard in federal deposit insurance, Independent Review 4(2): 241–254. See also Bhattacharya, S., Boot, A.W.A. and Thakor, A.V. (1998) The economics of bank regulation. Journal of Money, Credit and Banking 30(4): 745–770; and Thies, C. F. and Gerlowski, D.A. (1989) Deposit insurance: A history of failure. Cato Journal 8(3): 677–693.

  18. Economides, N., Hubbard, R.G. and Palia, D. (1999) Federal deposit insurance: Economic efficiency or politics? Regulation 22 (3): 15–17.

    Google Scholar 

  19. It is questionable how effective the FDIC is in distinguishing between bank illiquidity and insolvency. Kaufman (1999) finds that over 90 per cent of emergency lending during the US S&L crisis in the 1980s went to institutions that subsequently failed. See: Kaufman, G. G. (1999) Do lender of last resort operations require bank regulation? Paper presented at the American Enterprise Institute conference, Is Banking Regulation Necessary? Washington DC, 27 October.

  20. While essentially identical to the common demand deposit, the NOW account is a remnant of Regulation Q. Active until July 2011, Regulation Q mandated that interest could not be paid on demand deposits. NOW accounts were structured to comply with Regulation Q while still providing an interest-bearing deposit account. Regulation Q once allowed for an ‘artificially sharp distinction between no-yield money and no-check savings’, which in turn allowed the Federal Reserve more defined control over the money supply (Garrison, 2009: p. 190). This sharp distinction was no longer necessary as monetary policy moved from money-supply targeting to interest-rate targeting under the Volcker Fed. See: Garrison, R.W. (2009) Interest-rate targeting during the great moderation: A reappraisal. Cato Journal 29(1): 187–200.

  21. Federal Deposit Insurance Corporation (FDIC) (2013) Your insured deposits, http://www.fdic.gov/deposit/deposits/insured/print/yid_english.pdf, accessed 28 June 2013.

  22. White, L.J. (1989) The reform of federal deposit insurance. Journal of Economic Perspectives 3 (4): 11–29.

    Article  Google Scholar 

  23. 12 C.F.R. § 337.6(b).

  24. Huerta de Soto.14 See also: Bagus, P. and Howden, D. (2009) The legitimacy of loan maturity mismatching: A risky, but not fraudulent, undertaking. Journal of Business Ethics 90(3): 399–406.

  25. It could be that deposit brokers are only more capable at seeking out higher interest rate products than common depositors are, in which case there would be no gain in financial knowledge by using a broker. At the same time, most brokers, financial planners and investment advisors must go through an accreditation process to obtain their license that involves readings or classes pertaining to the functioning of financial markets and the risks involved in specific products.

  26. As an example of imperfect regulatory solutions on deposits, many financial products now offered by banks are direct responses to bypassing remnant legislations, for example, sweep accounts to avoid reserve requirements or NOW and ATS accounts to avoid Regulation Q.

  27. Government Accountability Office (2013) Financial institutions: Causes and consequences of recent community bank failures, testimony before the Committee on Banking, Housing and Urban Affairs, U.S. Senate, 13 June, http://www.banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=703ee6fe-c8cb-4c7f-a5f1-773f2ab117b8.

  28. Bennett, R.L. and Unal, H. (2011) The Cost Effectiveness of the Private Sector Organization of Failed Banks, FDIC Center for Financial Research Working Paper No. 2009–11, FDIC Center for Financial Research, Arlington, VA, http://www.fdic.gov/bank/analytical/cfr/2009/wp2009/CFR_WP_2009_11.pdf; Osterberg, W.P. and Thomson, J.B. (1995) Underlying determinants of closed-bank resolution costs, In: A.F. Cottrel, M.S. Lawlor and J.H. Wood (eds.) The Causes and Costs of Depository Institution Failures. Amsterdam, the Netherlands: Kluwer Academic Press.

  29. Barth, J.R., Bartholomew, P.F. and Bradley, M.G. (1990) Determinants of thrift institution resolution costs. The Journal of Finance 45(3), Papers and Proceedings, Forty-ninth Annual Meeting, American Finance Association, Atlanta, Georgia, 28–30 December, pp. 731–754. Cook, D.O. and Spellman, L.J. (1994) Repudiation risk and restitution costs: Toward understanding premiums on insured deposits, Journal of Money, Credit and Banking 26(3), part 1: 439–459.

  30. Independent Community Bankers of America (2011) Letter from Independent Community Bankers of America to Sheila Bair, 29 April, http://www.icba.org/files/ICBASites/PDFs/cl042911.pdf, accessed 28 June 2013.

  31. Berlin, M. and Mester, L.J. (1999) Deposits and relationship lending. Review of Financial Studies 12 (3): 579–607.

    Article  Google Scholar 

  32. American Bankers Association (2011) Change rules governing core, brokered deposits, http://regreformtracker.aba.com/2011/05/aba-change-rules-governing-core.html, accessed 28 June 2013.

  33. Congressional Budget Office (CBO) (1990) Reforming Federal Deposit Insurance. The Congress of the United States.

  34. Holland, D.S. (1998) When Regulation was too Successful – The Sixth Decade of Deposit Insurance: A History of the Troubles of the U.S. Banking Industry in the 1980s and Early 1990s. Westport, CT: Greenwood Publishing.

    Google Scholar 

  35. An alternative method to mitigate the moral hazard of insurance on brokered deposits is to increase the insurance premium banks must pay to offer the product, as in Otsuka Ayabe (1985–1986). While this would, to some degree, lessen the existing level of moral hazard it does little to justify why insurance should be extended to this financial product at all. Similar arguments must take the Demand Deposit Equity Act of 1983 for granted, without reassessing whether all deposits are created equally and in equal need of insurance. Otsuka Ayabe, G. (1985–1986) The ‘brokered deposit’ regulation: A response to the FDIC’s and FHLBB’s efforts to limit deposit insurance. UCLA Law Review 33(2): 594–641.

  36. BankRegData (2013) Brokered deposits to deposits, http://www.bankregdata.com/allDPmet.ask?met+BRO, accessed 19 November 2013.

  37. Redburn, F.S. (1988) Never lost a penny: An assessment of federal deposit insurance. Journal of Policy Analysis and Management 7 (4): 687–702.

    Article  Google Scholar 

  38. cf. Seward, G.C. and Zaitzeff, R.M. (1983–1984) Insurability of brokered deposits: A legislative analysis. Business Lawyer 39 (4): 1705–1718.

    Google Scholar 

Download references

Author information

Affiliations

Authors

Corresponding author

Correspondence to David Howden.

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Howden, D. Rethinking deposit insurance on brokered deposits. J Bank Regul 16, 188–200 (2015). https://doi.org/10.1057/jbr.2014.5

Download citation

Keywords

  • deposit insurance
  • banking regulation
  • Dodd–Frank Act
  • brokered deposits