I. INTRODUCTION
Federal bank and thrift regulatory agencies issued an advisory reminding bankers of the potential risks associated with excessive reliance on brokered and other highly rate-sensitive deposits. The agencies warn that excessive reliance on these types of funding products without proper risk management safeguards has the potential to weaken an institution’s financial condition.
Deposit brokers have traditionally provided intermediary services for financial institutions and investors. The Internet and other automated service providers enable investors focusing on the highest returns offered within the financial industry to easily identify high-yielding deposit sources, however, customers who focus exclusively on rates are highly rate-sensitive and provide a less stable source of funding then do those with local retail deposit relationships. If market conditions change or more attractive returns become available, these customers may rapidly transfer funds elsewhere in a manner similar to that of wholesale investors.
Financial institutions that make use of significant amounts of brokered and rate-sensitive deposits should ensure that proper risk management practices are in place. The advisory issued by the regulatory agencies encourages practices such as control structures to limit concentrations in this type of funding, due diligence in assessing deposit brokers and the risk to earnings and capital, and management information systems that identify non-relationship or higher cost funding sources that can be monitored and managed.
II. BROKERED AND RATE-SENSITIVE DEPOSITS
Under federal law, determination of “brokered” status is based initially on whether a bank actually obtains a deposit directly or indirectly through a deposit broker. Banks that are considered only “adequately capitalized” under the “Prompt Corrective Action” standard must receive a waiver from the FDIC before they can accept, renew, or roll over any brokered deposit. They are also restricted in the rates they may offer on such deposits. Banks falling below the adequately capitalized range my not accept, renew, or roll over any brokered deposit nor solicit deposits with an effective yield more than 75 basis points above the prevailing market rate. These restrictions serve to reduce the availability of funding alternatives as a bank’s condition deteriorates. A bank manager utilizing brokered deposits should be familiar with the regulation governing brokered deposits and be cognizant of the requirements for requesting a waiver. See, NBA Compliance Handbook, Volume II, Deposit Accounts section, “Interest on Deposits and Reserve Requirements: Brokered Deposits Regulation” article above.
Deposits attracted over the Internet, through CD listing services, or through special advertising programs offering premium rates to customers without another banking relationship also require special monitoring. Although these deposits may not technically qualify as “brokered”, their inherent risk characteristics are similar to brokered deposits. Such deposits are typically attractive to rate-sensitive customers who may not have significant loyalty to the bank and extensive reliance on funding products of this type, especially those obtained from outside a bank’s geographic market area, has the potential to weaken a bank’s funding position.
III. RISK MANAGEMENT GUIDELINES
The regulatory agencies expect bank management to implement risk management systems commensurate in complexity with the liquidity and funding risks undertaken. The principals required to be incorporated into such risk management systems should include the following:
A. Proper Fund Management Policies
Bank policy should generally provide for forward planning, establish an appropriate cost structure and set realistic limitation and business strategies. The policy should clearly convey the board’s risk tolerance and should clearly delineate who holds responsibilities for funds management decisions.
B. Adequate Due Diligence When Assessing Deposit Brokers
Bank management should implement adequate due diligence procedures prior to entering any business relationship with a deposit broker.
C. Due Diligence and Assessing the Potential Risk to Earnings and Capital Associated with Brokered or Other Rate-Sensitive Deposits, and Prudent Strategies for Their Use
Bankers should manage highly sensitive funding sources carefully, avoiding excessive reliance on funds that may be only temporarily available or which may require premium rates to retain.
D. Reasonable Control Structures to Limit Funding Concentrations
Bank policy should consider typical behavior patterns for depositors or investors and be designed to control excessive reliance on any significant source(s) or type(s) of funding, including brokered funds, and other rate-sensitive or credit-sensitive deposits obtained through the Internet or other types of advertising.
E. Management Information Systems (MIS) That Clearing Identify Non-Relationship or Higher-Cost Funding Programs and Allow Management to Track Performance, Manage Funding Gaps, and Monitor Compliance with Concentration and Other Risk Limits
The MIS, at a minimum, should include a listing of funds obtained through each significant program, rates paid on each instrument and an average per program, information on maturity of the instruments, and concentration or other limit monitoring and reporting. Management should also ensure that brokered deposits are properly reported in Consolidated Reports of Condition and Income.
F. Contingency Funding Plans that Address the Risk That These Deposits May Not “Roll Over” and Provide a Reasonable Alternative Funding Strategy
The bank should have a contingency funding plan which factors in the potential for changes in market acceptance if reduced rates are offered on rate-sensitive deposits. Consideration should also be given to the potential for triggering legal limitations that restrict the bank’s access to brokered deposits under Prompt Corrective Action standards, and the effect that this would have on the bank’s liability structure.
IV. EXAMINATION GUIDELINES
Examiners will carefully assess the liquidity risk management claim work at all banks, with banks having a significant reliance on brokered or other rate-sensitive deposits receiving the appropriate level of supervisory attention. If a determination is made that a bank’s use of these funding sources is not safe and sound, or that these risks are excessive or that they adversely affect the condition of the institution, appropriate supervisory action will be immediately taken. Potential “red flags” that may indicate the need for regulators to take action to ensure the risks associated with brokered or other rate-sensitive funding sources are managed appropriately include: