Paul Clark, Casey Jennings and Nathan Brownback

The delivery of banking and investment products and services has been forever altered by new technologies that permit financial institutions to provide these products and services through increasingly sophisticated websites and APIs, or apps. Consumers check bank balances, make deposits and payments, submit loan applications and conduct other banking business using their smart phones. Online brokerage and wealth management firms offer cash management services, including checking and debit cards accessing FDIC-insured deposits, that can replace other aspects of a consumer’s traditional banking relationship.

In many cases, the company offering a banking app is a so-called neo-bank, not a licensed bank. If you asked customers of Chime, Digit or Yotta where they bank, the most likely answer would probably be Chime, Digit or Yotta, none of which are banks. Yet Chime’s website refers to “Banking that has your back” and Yotta uses “FDIC” prominently on its website. (In May 2021, Chime entered into a settlement agreement with the California Department of Financial Protection and Innovation in which it agreed to remove references to the words “bank” and “banking” on its website and in certain marketing materials, and to clarify in those materials that it is not a bank.)

These nearly frictionless delivery methods are revolutionizing the relationship between consumers and their financial institutions by reducing the need for traditional bricks-and-mortar branches and their staff. Yet many of these innovative delivery methods rely on a decades-old financial service: brokered deposits.

Brokered deposits permit banks to offer FDIC-insured deposits without a physical branch network. Putting aside for the moment the legal definition in the FDIC’s regulations, a deposit is “brokered” when it originates from an intermediary—a broker—acting on behalf of one or more depositors. Under the FDIC’s “pass-through” deposit insurance rules, if the broker places the funds in a single deposit account at a bank in the broker’s name for the benefit of the broker’s customers and maintains records of each customer’s ownership in the account, each customer is insured as if they had opened the account directly with the bank.

Brokered deposits, both the product and the term, were introduced in the early 1980s by the large retail brokerage firms to offer their customers CDs with competitive market yields and FDIC insurance on a pass-through basis. What did the banks get? Because the brokers had the customer relationships and hold the CDs as agent for their customers, banks were able to raise term deposits without the expense of branches, marketing, customer service, periodic customer statements, KYC requirements, or Form-1099 tax reporting. These costs were assumed by the brokers.

The next major product innovation was the so-called “sweep” program, offered by brokers, through which uninvested customer funds at a broker are deposited into savings or demand deposit accounts established by the broker at one or more banks in a manner permitting FDIC insurance to pass through to customers. These programs provide the same efficiencies to banks as CD programs.

Many, if not all, of the FinTech brokerage and wealth management platforms provide banking services (such as bill payment, fund transfers, debit cards, and checking) through a customer’s brokerage account that includes FDIC-insured bank deposits. Look at the websites for Betterment, WealthFront, Robinhood, Aspiration, or Brex. What are they offering? A sweep program with checking and payment features using brokered deposits. And, yes, Merrill Lynch did introduce the Cash Management Account in the late 1970s. Deja vu all over again.

PayPal, which revolutionized customer payments, claimed FDIC pass-through insurance on funds it held for customers at the time in a 2002 letter to the New York banking regulator, arguing that it was acting as the customer’s agent and, therefore, was not a bank. PayPal later stopped claiming the availability of FDIC insurance on these funds and registered with the states as a money transmitter. More recently, PayPal and other payment providers have come full circle and begun to offer accounts eligible for pass-through FDIC insurance on funds held through certain payment features. In addition to other quasi-banking and full banking services PayPal is offering, it too is offering brokered deposits.

Can we say that brokered deposits were the first FinTech product?

Brokered deposits are regulated under a statute adopted in 1991, before some of the founders of prominent FinTech firms had even been born. The statute is unchanged in all material respects since its adoption.

The FDIC recently adopted amendments to its brokered deposit regulations, stating that it intended to provide relief from the brokered deposit limitations for the FinTech industry. In this regard, the FDIC’s amendments provide relief for FinTechs that partner with one bank only and to payments providers generally. But the relief granted, along with glaring gaps in the amendments, is hard to square with a consistent approach to regulating deposit funding.

The FDIC says it is concerned that brokered deposits might lead to rapid asset growth or deposit instability, but the FDIC provides relief for some deposit arrangements with hallmarks of instability (such as those placed by payments providers), while creating roadblocks to relief for deposit arrangements that provide demonstrably more stable funding, such as many sweep programs. It should also be noted that the relief for one-bank FinTech arrangements is predicated on the presumed stability of the deposits, a factor not mentioned in the statute, which speaks solely to the types of relationships that cause a person to be a “deposit broker.” And, of course, deposits attracted by offering high rates over the internet or through a listing service remain untainted by the “brokered” label.

Since it is unlikely that Congress will address the brokered deposit issue any time soon, we believe the FDIC should take the simple step of saying “we don’t care if deposits are brokered.” The FDIC, along with the other banking regulators, should remove references to brokered deposits in other regulations and policies, such as deposit insurance premiums and the definition of “core” deposits. Deposit stability and rapid asset growth by banks should be managed by regulators on a case-by-case basis or, if these are deemed systemically important issues by the regulators, through regulations aimed specifically at these potential problems that are adopted after an opportunity for public input.

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The authors are attorneys in the Washington, DC, office of Seward & Kissel. Paul Clark is the author of Just Passing Through: A History and Critical Analysis of FDIC Insurance of Deposits Held by Brokers and Other Custodians.¹