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Retirement Savings: How Much Should I Save Each Month?Brokered Deposits and Hot Money - Factors in Bank Failures?
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ON BY Ken Tumin
This New York Times article looks at how hot money is being considered as an important factor in accelerating the wave of bank failures. With 52 bank failures so far in 2009, the causes for these failures are being examined. Unfortunately, regulators seem to be focusing more on deposit rates than the real problem of risky loans.
The article focuses mostly on brokered deposits. Brokered deposits are typically CDs that are sold to customers by brokerage companies like Charles Schwab. The brokerage acts as an intermediary with the bank which actually holds the deposits. The article has a good description of why brokered deposits are blamed:
When a bank fails, brokered deposits make it more difficult for the FDIC to find a buyer for the bank. Even if the FDIC finds a buyer, they may still refuse to assume brokered deposits. Looking over my posts on this year's bank closures, I've counted 12 banks that didn't assume brokered deposits in their agreements to take over the failed banks.
For a bank who's taking over the deposits of a failed bank, the issue with brokered deposits is that they can be easily moved from one bank to another as brokers seek the highest rates. The only thing that keeps those deposits is the high interest rates. To me this sounds a little like internet savings accounts. With electronic transfers it's easy to move money from one account to another. Also, when accounts have little or no minimum balance requirements, you can move most of the money without the hassles of closing and opening accounts.
With the FDIC reviewing Ally Bank rates, it's apparent that the regulators have noticed internet accounts can be another source of hot money. It's likely that we'll see more regulations on internet accounts. The article ends with the following:
In my opinion, the focus of regulators should be on risky loans and not high deposit rates. The problem with focusing on deposit rates is that it may punish banks which are not depending on risky loans. A good example is a bank offering a high interest rate on a reward checking account. Without understanding reward checking, regulators may see a 4% rate on a checking account to be hot money. In reality, the bank is able to pay 4% for a number of reasons unique to reward checking accounts. It's not necessarily through the use of risky loans.
Thanks to the reader who mentioned this article in the comments.
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The article focuses mostly on brokered deposits. Brokered deposits are typically CDs that are sold to customers by brokerage companies like Charles Schwab. The brokerage acts as an intermediary with the bank which actually holds the deposits. The article has a good description of why brokered deposits are blamed:
Rather than simply wooing local customers, they have turned to out-of-state brokers who deliver billions of dollars in bulk deposits, widely known as "hot money," from investors nationwide.
...
But the hot money also came with a high cost. To lure the money from brokers, banks typically had to offer unusually high rates. That, in turn, often led them to make ever riskier loans, leaving them vulnerable when the economy collapsed.
When a bank fails, brokered deposits make it more difficult for the FDIC to find a buyer for the bank. Even if the FDIC finds a buyer, they may still refuse to assume brokered deposits. Looking over my posts on this year's bank closures, I've counted 12 banks that didn't assume brokered deposits in their agreements to take over the failed banks.
For a bank who's taking over the deposits of a failed bank, the issue with brokered deposits is that they can be easily moved from one bank to another as brokers seek the highest rates. The only thing that keeps those deposits is the high interest rates. To me this sounds a little like internet savings accounts. With electronic transfers it's easy to move money from one account to another. Also, when accounts have little or no minimum balance requirements, you can move most of the money without the hassles of closing and opening accounts.
With the FDIC reviewing Ally Bank rates, it's apparent that the regulators have noticed internet accounts can be another source of hot money. It's likely that we'll see more regulations on internet accounts. The article ends with the following:
Ms. Bair said she planned to ask Congress for greater powers to limit the role of hot money in banking - be it brokered deposits, listing services or simply Internet sales by banks offering unusually high interest rates.
In my opinion, the focus of regulators should be on risky loans and not high deposit rates. The problem with focusing on deposit rates is that it may punish banks which are not depending on risky loans. A good example is a bank offering a high interest rate on a reward checking account. Without understanding reward checking, regulators may see a 4% rate on a checking account to be hot money. In reality, the bank is able to pay 4% for a number of reasons unique to reward checking accounts. It's not necessarily through the use of risky loans.
Thanks to the reader who mentioned this article in the comments.
Related Posts: