Brokered Deposits (Marty's Version)

Amid Slow Progress, Synapse Bankruptcy Victims Speak Out In Email To Judge

Aug 18, 2024

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Brokered Deposits (Marty’s Version)

Almost a year ago, I asked the question, is the term “brokered deposits” fit for purpose in the age of fintech?

Brokered deposits were first regulated in the wake of the 1980’s savings and loans crisis via the passage of 1989’s Financial Institutions Reform, Recovery, and Enforcement Act, which added Section 29 to the Federal Deposit Insurance Act.

Section 29 provides a statutory definition of “deposit broker” in part as “any person engaged in the business of placing deposits, or facilitating the placement of deposits,” with a number of exceptions.

The FDIC argues that brokered deposits can increase the cost to the deposit insurance fund when banks that hold them fail, especially when an institution uses them to grow quickly. Thus the statute and implementing regulations place restrictions on less-than-well capitalized institutions holding brokered deposits and may charge higher deposit insurance assessments for banks holding them.

It seems the question of brokered deposits has been on the mind of FDIC directors again as well, with the the board voting 3-2 along party lines last month to introduce a notice of proposed rulemaking that would functionally reverse the 2020 changes to the brokered deposit rule.

How will the newly proposed rule change what rules finalized in 2020? Find the full comparison chart and accompanying blog post at Troutman Pepper here.

FDIC Chair Martin Gruenberg, who, as a director at the time, voted against the 2020 change, was joined by Acting Comptroller Hsu and CFPB Director Chopra in voting to approve the proposed rule. Directors Travis Hill and Jonathan McKernan voted against the proposed rule.

At the time the 2020 rule change loosening restrictions on brokered deposits was being debated, then-FDIC Chair Jelena McWilliams and then-Acting Comptroller Brian Brooks explicitly argued that the change would encourage bank-fintech partnerships, which would support innovation and access and inclusion.

The fact sheet accompanying the 2020 rule change stated (emphasis added):

“The final rule seeks to ease access to deposits for U.S. customers, including unbanked and underbanked customers. Today, customers want to access banking services through different channels, and the new framework established by the final rule removes regulatory disincentives that limit banks’ ability to serve customers the way customers want to be served.”

Then-Chair McWilliams wrote at the time (spacing adjusted and emphasis added):

“First, the framework would create a more transparent and consistent regulatory approach by establishing bright line tests for the ‘facilitation’ prong of the deposit broker definition and a consistent process for application of the primary purpose exception.
Second, the final rule would encourage innovation in how banks offer services and products to customers by reducing obstacles to certain types of partnerships. And, it would continue to protect the Deposit Insurance Fund.”

And then-Acting Comptroller Brooks wrote (spacing adjusted and emphasis added):

“Under the previous status quo, the broad definition of brokered deposits discouraged bank and fintech partnerships by imposing unnecessary burden and costs—specifically, by deeming app-based fintech services that facilitate consumer savings accounts potential deposit-brokering activity.
This rule recognizes that fintech partnerships help banks reach new customers and extend their services to previously unbanked and underserved populations without triggering onerous regulatory requirements.”

Then-Director Gruenberg, voting against the 2020 rule change, argued in part that the updated rule didn’t take into consideration how technology impacts the relationship between depositors, third-party intermediaries, and insured depository institutions, writing (spacing adjusted and emphasis added):

“The premise for this Final Rule, as for the NPR, appears to be adjustment to technological change in the banking industry. However, an examination of the proposed changes indicates they relate less to technological change than to interpreting the Federal Deposit Insurance Act to dramatically narrow the universe of deposits that are considered brokered.
This has safety and soundness consequences because, under the Federal Deposit Insurance Act, a bank that is not well capitalized may not accept brokered deposits…
While technology may have a role to play, the Final Rule has not addressed how technology changes the fundamental considerations of the relationship between a bank, a depositor, and a third party intermediary, and the risks the relationship may pose.”

Now, with the clock ticking on his time remaining as FDIC Chair, Gruenberg is seizing the opportunity to reverse the 2020 changes he opposed in the first place — but he relies more on anecdote than data and sound logic in arguing his case.

Gruenberg points to the still-ongoing Synapse/Evolve catastrophe as an example of, what he argues, is the “uncertain nature” of third party funding arrangements. Gruenberg writes in part (spacing adjusted and emphasis added):

“Experience has shown they can be highly unstable, with either the third party or the underlying customers moving funds based on market conditions or other factors. These arrangements can also be prone to other forms of disruption such as the potential or actual insolvency of the third party, as was recently demonstrated by the bankruptcy of Synapse Financial Technologies, Inc. (Synapse).
Synapse, sometimes referred to as a fintech ‘middleware’ company, was a deposit broker that facilitated customer deposits for various fintech companies looking for banking services with insured depository institutions.”

Gruenberg also points to the failure of crypto platform Voyager, which held users’ dollar-denominated funds at Metropolitan Commercial Bank, writing in part (spacing adjusted and emphasis added):

“[T]he crypto company Voyager was not considered a ‘deposit broker’ — and therefore deposits it placed in its partner bank were not considered brokered — merely because it had an exclusive deposit placement arrangement with one bank…
As a result, when Voyager failed in 2022, it created the same legal, operational, and liquidity risks for its partner bank as if it had been classified as a deposit broker.
Specifically, Voyager’s partner bank, experienced several risks related to Voyager’s sudden bankruptcy, including, but not limited to: (i) legal risk related to customers’ lack of access to their funds for several weeks; (ii) earnings risk related to legal fees and increases in interest expense as a result of the loss of the low-cost Voyager deposits; and (iii) liquidity risks related the need to replace the Voyager deposits once the bankruptcy court cleared release of the funds to end users.”

Yet, it’s not clear to me that, had the 2020 rule change never come to pass and Voyager’s and Synapse’s deposits were consistently deemed to be “brokered,” it would have made any difference in either situation.

At the time Voyager collapsed in 2022, Metropolitan Commercial Bank was well-capitalized, with a leverage ratio over 9%, a tier one capital ratio over 13%, and a total capital ratio over 14%.

And Evolve, despite its many troubles, reports that it is well capitalized, with a leverage ratio of 10.3%, a tier one capital ratio of 14.8%, and a total capital ratio of 16%.

Although Metropolitan and Evolve may have paid a higher deposit insurance assessment had deposits from Voyager and Synapse, respectively, been considered “brokered,” neither bank would have faced a prohibition on accepting such deposits.

Gruenberg’s argument fails to make clear how reversing the 2020 rule change could have prevented either failure — both of which, notably, were failures of non-bank entities.

Gruenberg also points to 2023’s “regional banking crisis,” including the failure of First Republic, in making his case. He specifically cites the significant outflow of uninsured affiliated sweep deposits — deposits from a broker-dealer associated with First Republic above the $250,000 insurance cap.

Gruenberg argues that “[t]his case suggests that affiliated sweeps, particularly those that are uninsured, are no more ‘sticky’ than unaffiliated sweeps, contrary to a provision in the 2020 Final Rule that expressly exempts affiliated sweeps from being considered brokered.”

Yet again, First Republic was considered well-capitalized before its failure, with a leverage ratio of 8.2%, a tier one capital ratio of 11.7%, and a total capital ratio of 12.7% — meaning the bank wouldn’t have been prohibited from taking such deposits, even if they had been deemed brokered.

Hill Calls Brokered Deposits Regime “No Longer Fit For Purpose”

For his part, Director Hill, who voted against the reversal, provided some insight into his thinking at a speech at the American Enterprise Institute.

Hill began his thoughts on brokered deposits by saying, (emphasis added) “The brokered deposits framework was first put in place by Congress in 1985. 35 years later, I believe that the regime is no longer fit for purpose.”

Hill summarized the impact of classifying a deposit as brokered vs. not by saying (spacing adjusted):

“The principal consequences of a deposit being classified as brokered are
(1) a ‘tax’ in the form of higher deposit insurance assessments and more punitive treatment under liquidity rules,
(2) limitations on the ability of a bank to accept such a deposit if the bank falls below well-capitalized, and
(3) in some cases, a reflexive judgment by examiners that the deposit is ‘risky.’ The first is provided by rule, the second required by statute, and the third varies by examiner and agency.”

Yet, Hill argues (and I tend to agree), that, today, deposits characterized as brokered can exhibit diametrically opposed characteristics. Hill writes (spacing adjusted and emphasis added):

“Some types of brokered deposits raise safety and soundness concerns out of fears that they are volatile, unstable, or otherwise likely to be withdrawn if the bank experiences turmoil or negative attention.
On the other hand, traditional brokered deposits present the opposite concern — the deposits have no franchise value because the depositors have no relationship with the bank, earn high rates, are fully insured, generally cannot withdraw before maturity, and thus are generally indifferent to the condition of the bank, but are incredibly stable.”

In The Future, Will All Money Be “Hot”?

There’s no question that the collapse of Synapse, or Voyager before it, has had severe negative consequences — for the banks they partnered with, surely, but even more so for end customers, many of whom still cannot access their funds, in the case of Synapse.

But the argument that treating funds from these firms as brokered deposits would’ve somehow prevented their collapse is unconvincing.

Further, Silicon Valley Bank, the failure of which touched off last spring’s banking crisis, didn’t hold a single dollar in brokered deposits at the time it failed — rather, interest rate risk and a high proportion of concentrated, closely networked, uninsured direct deposits contributed to its failure.

The argument over the definition of brokered deposits misses the point: the characteristics, behavior, and thus riskiness of all deposits have and continue to change. The distinction of brokered or not is no longer an accurate indicator of the “hotness” of deposits.

As my industry colleague and Fintech Takes author Alex Johnson argues this week, “the future of money will be hot by default.”

First web and then mobile banking, data portability via open banking infrastructure, faster payment rails like RTP and FedNow, and, eventually, AI agents all mean money, regardless of whether it is considered brokered or not, is likely to be “hotter,” or less sticky, than it has been previously.

And these are all innovations that have been good for consumers, even if they are changing banks’ long-held assumptions about the stickiness of certain kinds of deposits.

In fact, there is already academic analysis that supports the argument that banks with digital platforms see higher deposit betas and that deposits flow out more quickly during periods of rising rates.

Rather than re-litigating past battles about the definition of brokered deposits, the FDIC would be better served by developing an understanding of how deposits behave as a function of all relevant, modern characteristics: insured vs. uninsured, a direct retail customer vs. via a third-party, such as a broker or fintech app, the interest rate the bank is paying, and so forth.

Last September, I opined on the relative riskiness of BaaS-sourced deposits, writing at the time (emphasis added):

On the one hand, BaaS-sourced deposits could strengthen a bank’s balance sheet, by enabling it to diversify its sources of funding beyond a limited geographic area or industry concentration (an argument Alex Johnson made in the wake of SVB’s collapse earlier this year.)
On the flip side, if partner bank- or BaaS-facilitated deposits are at risk of abrupt or coordinated withdrawal — for instance, if a neobank failed or if the BaaS platform has the ability to shift deposits to a different bank — a dependence on them could pose a safety and soundness risk.

Now, proposed change to the brokered deposit rule notwithstanding, it seems the FDIC is trying to gain a better understanding of how different types of deposits behave in different scenarios. During the same board meeting, the FDIC issued a request for information on deposits.

The request for information “seeks information on the characteristics that affect the stability and franchise value of different types of deposits and whether more detailed or more frequent reporting on these characteristics or types of deposits could enhance offsite risk and liquidity monitoring; inform analysis of the benefits and costs associated with additional deposit insurance coverage for certain types of deposits; improve risk sensitivity of deposit insurance pricing; and provide analysts and the general public with accurate and transparent data.”

While the FDIC’s request for information will likely be invaluable in formulating future regulations regarding different types of deposits, it seems like it would have been prudent to gather such information to inform its decision making prior to moving to reverse the 2020 brokered deposits rule.

Amid Slow Progress, Synapse Victims Speak Out In Email To Bankruptcy Judge

Last week saw a status report and hearing in the ongoing Synapse bankruptcy. For some users, it’s now been more than three months since they’ve had access to their funds, and the situation is taking a toll.

The status reported filed on August 14th revealed little additional progress since the last hearing, about two weeks ago. No additional DDA funds have been disbursed since then, and only about $1 million of additional FBO funds have been released, by AMG National Trust.

AMG National Trust has distributed about $1 million of additional FBO funds since the last hearing. To date, Lineage and Evolve have disbursed no FBO funds since they were effectively frozen on May 11th.

Both Lineage and Evolve represent that they need additional time to complete reconciliation. Lineage continues to expect that it will begin disbursing funds by the end of August.

For its part, Evolve hasn’t yet obtained all the data it says it needs to undertake reconciliation, though that process should be complete soon if it isn’t by now.

Evolve has also engaged consulting firm Ankura, as of July 29th, and, per Fintech Business Weekly’s prior reporting, former Synapse employees to assist in its reconciliation efforts.

Once it has obtained all the data it is seeking, Evolve expects the reconciliation process to take approximately two additional months — meaning that, for some users, by the time they receive their money back, it could have been as long as five months.

Curiously, the status report also claims that the Chapter 11 trustee “was informed that, sometime in fall 2023, Synapse Brokerage had deployed a sweep network at American Deposit Management Company” — despite this being public knowledge for some time, including being mentioned in previous of the trustee’s status reports.

According to the trustee’s status report, the 19 sweep network banks Synapse used via ADMC were aware they held money for ADMC’s clients, but “did not maintain records relevant to the specific clients [Synapse] or clients’ end users.”

Per the trustee’s conversations with ADMC, all remaining Synapse-related funds were withdrawn from ADMC’s sweep network banks by May 14th, 2024 — meaning no end user funds should currently be held at ADMC sweep banks.

Impacted Users’ Statements Make Abstract “Collateral Damage” Tangible

There was another entry in the Synapse bankruptcy docket last week: an email from an impacted end user to the judge, which included stories from about 100 customers of fintechs, primarily Yotta and Juno.

The user who collected the statements noted that they “100% believed [their] money was safe using Yotta,” as “[their] money was FDIC insured and at an FDIC insured bank.”

The real-life impacts to some end users has been harrowing, with anecdotes that include (emphasis added through out):

A user who said they were selling “blood and bone marrow” to try to make rent and was considering suicide: “I’m living hand-to-mouth, week-to-week, selling my blood and bone marrow to try and make rent again this month. Nobody has stepped into help, federally speaking, and it’s taken a serious toll on my mental and physical health. My hair is falling out in clumps and I briefly considered suicide. I just want my hard-earned, taxed, carefully budgeted life savings back.”
Users who were relying on savings to escape bad situations: “For the past 3 years, I’ve been saving up in secret to nearly $66,000 of my income in order to get out of my toxic household, eventually earn a professional degree, and essentially get my life together.”
Frustrated users unable to get answers no matter who they ask: “I have reached out to CFPB, SEC, FINRA, FDIC, both my senators, my congress representative, OCC, NYS attorney general, evolve bank, the federal reserve, SPIC and the house committee on finance. I have gotten little response back and absolutely no idea on how I can go about getting my money back,” “The federal government has absolutely failed us.”
Negative impacts to credit history and credit score from being unable to make payments on debts: “I was laid off 2 months ago and my unemployment doesn’t even cover my mortgage. I’m behind on all of my debts and my credit score is dropping by the day. This is an absolute nightmare. I’m my only source of income and I cannot access my funds, this is devastating.”
Frustration that users weren’t made aware of the risks of services like Yotta: “Had I known Yotta was moving my money to a place that would cause me to lose access to my funds, I would have taken my money elsewhere. I feel as though they did not appropriately notify me/gain consent to make a riskier change to my account. This whole situation has blindsided me and crippled me financially.”
Concern about how they’ll pay for critical life events, like the birth of a child: “This money was earmarked for the birth of my first child and hospital expenses etc. which is happening in August. My wife does not get FMLA and is unemployed due to complicated pregnancy. I have no other savings or family support. That money was vital to the birth of my child and now I have nothing and don’t know what to do.”
Determination to fight to get back what is frozen: “I don’t care about compensation or suing anyone. I just want to withdraw my money that I took years to save. It feels like I'm getting robbed and there's nothing I can do. I will fight this the rest of my life if I have to.”
Users outside the US who are also caught up in the bankruptcy: “I am from Argentina. Yes, you read that right, from Argentina. Born and raised. The magnitude of this Synapse financial disaster has reached people all over the world, not just US citizens. Many fintechs in Latin America offer the service of opening a US account in simple steps and with few requirements... It has harmed me enormously. I can barely bear the situation, since in Argentina the situation is very difficult. I want to highlight the generosity of a Reddit user from the Yotta forum, also affected, who helped me selflessly with the rent payment for the month of June, taking a great weight off my shoulders.”
Users who couldn’t access critical benefits payments: “I was In Harborview hospital in Seattle, ready to be discharged to home nursing in my new apartment. I had broken my spine, for the third time. I had my social security backpay of 5,000.00 in juno and I attempted to transfer it out may 16th, but the transfer failed. I was to pay my move in expenses with it.”
Users whose life plans, like buying a house, were disrupted: “I am reaching out to express my deep frustration and disappointment with Yotta’s handling of my funds. On May 16, 2024, I withdrew $9,196.40 from my Yotta account, urgently needed for the closing of a new house my partner and I are purchasing. The closing was set for May 20, 2024.”
Users who saved up for a dream, like starting their own business, only to see those hopes dashed: “I was saving up to quit my day job and start my own business, which has been a dream of mine for a tong time. I work at a soul-sucking job, and this dream of finally being able to pursue my dreams was all that was keeping me going… I was two weeks away from turning in my notice when my funds were frozen. Every day I’ve had to go back into the office since then has been another twist of the knife in my soul. I am really struggling mentally. This dream was what was keeping me going. I don’t know how long I can keep going without knowing if or when I’ll get my money back.”

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