Charlie Knadler is president and CEO of EnerBank USA. Opinions expressed are author's own.
Banks are a part of life for just about every consumer — only 7% of Americans don't have an account. For most, it's a necessity to manage money, build wealth and gain access to credit. Accordingly, we depend on the security of our financial institutions.
Between new technology and emerging generations who are moving their financial activities increasingly online, the trend is moving quickly toward more nationwide banks and fewer branch offices. Consumers just don't need or want to go to branches as often — in fact, of the top 10 nationwide banks in the U.S., only one increased its number of branches from 2017 to 2018.
One of the consequences of online banking is consumers can switch banks relatively painlessly, and the cost of changing banks is lower than ever. Previously, a consumer had to visit the branch, fill out paperwork, provide proof of identity, and then fill out a pile of paperwork at their new bank. Today, however, customers can change banks far more easily from a computer or mobile device.
The net result is that core deposits are less "sticky."
These trends require a different view of brokered deposits. The current thinking puts a high value on deposits of customers who could switch banks at any moment.
Bank failures traditionally happen in two ways: 1) a liquidity crisis, or 2) poor asset quality. For reasons that make little sense and have little data support, regulators traditionally have viewed brokered CD deposits as risky from a liquidity perspective.
It's time to see brokered deposits for what they truly are: a predictable source of funding for branchless banks and more traditional banks that diminishes risk and supports reliability.
For the 472 Federal Deposit Insurance Corp.-insured banks that failed between 2004 and 2013, FDIC financial data showed a dramatic shift from lower troubled asset ratios to higher troubled asset ratios (from 20.6% to 241.5%, on average) during the three-year period preceding the failures.
A "bank run" is the greatest liquidity-related threat to a bank. It happens when depositors, en masse, withdraw their deposits from an institution for any number of public concerns. Whether the withdrawals are warranted or not, they create a cascading effect, resulting in additional withdrawals that could lead to the bank's insolvency. A bank that predominantly holds traditional core deposits is susceptible to such a risk, whereas a bank funded primarily or solely by brokered CD deposits is not. That's because these deposits have precise maturity dates. Customers can only withdraw their funds before maturity if the depositor dies or is declared legally incompetent.
By using brokered CD deposits, banks can fund balance sheets in lock-step with loan growth in any economic environment. Core deposits typically surge during recessions when loan growth is low, and leave the bank when the economy improves and loan growth strengthens, inhibiting banks' ability to serve their customers.
Right now, the difference between the way that many in the regulatory community view core deposits and brokered CD deposits is inconsistent with the structure of those deposits. Brokered CD deposits are inherently stable and predictable with next to no risk of early withdrawal, while core deposits are increasingly unpredictable and, thus, potentially unstable.
In fact, regulators often associate brokered deposits with unsustainable asset growth, particularly in risky assets, high volatility, low franchise value. EnerBank, for example, uses brokered deposits to fund its super-prime portfolio of home improvement loans. The vast majority of its peers at branchless banks are likewise using brokered deposits to fund high-quality loan portfolios.
At a high level, existing brokered deposit statutes say a bank needs to be well-capitalized to use brokered deposits. But the stigma associated with using brokered deposits — increased scrutiny during exams and increased deposit insurance assessments associated with significant use of brokered deposits — should be removed.
Appropriate attention and review of these issues will make the banking industry both safer and more successful for all.