Special Episode Deposits Hot or Not

Welcome to Breaking Banks, the number one global fintech radio show and podcast. I’m Brett King. And I’m Jason Henricks.

Every week since 2013, we explore the personalities, startups, innovators, and industry players driving disruption in financial services. From incumbents to unicorns, and from cutting edge technology to the people using it to help create a more innovative, inclusive, and healthy financial future. I’m J.P. Nichols, and this is Breaking Banks.

Kia Hatzlitt has a bucket list item to do an entire Breaking Banks dedicated to deposits. If Seinfeld could make a show about nothing entertaining, well, we were up to the challenge when it comes to deposits. In this episode, Kia’s dreams do come true as we join Alex Johnson to talk about broker deposits.

Are they hot or not? Kia and Alex both bring the heat with Breaking Banks custom hot sauce. You’ll want to listen or at least skip ahead to the last 10 minutes of this episode of Hot Wings and Hot Takes, where Kia and I engage in a round robin of hot or not, while under the influence of, oh no, my bank partner ghosted me ghost pepper sauce. None of the members of this show were injured in the recording.

However, most of us couldn’t feel our lips for the rest of the day. Is everyone sick of talking about Silicon Valley Bank yet? I am so sick of the number of banking and AML experts that have come out of the woodwork. I wish they would really go back to epidemiology and all of their other area of expertise.

So let’s pick up some hot topics that aren’t often discussed. Broker deposits, frequently referred to as hot deposits and the implications for banking as a service, because yes, the Silicon Valley Bank debacle is not over. Before we get to that, this show is sponsored by Hot Wings and Hot Takes, Jason’s very own set of custom hot sauces for when things get spicy.

This is the KYC Oh No Garlic Habanero, the OCC Chipotle, and my personal favorite, my bank partner ghosted me ghost pepper. Alex, what have you busted into first? Because I see you’re connoisseur of, oh yeah. I knew what we were going to talk about.

I knew we were talking about bank partners and banking as a service. So I figured I’d just dial it all the way up to 11 immediately and just go with my bank partner ghosted me. Well, Kia, before you lose your voice getting into this, let’s kick us off here.

Hot topic, what is a broker deposit? Well, I’m so excited that I finally convinced someone to talk about broker deposits to me, nevermind two people. So a broker deposit is a type of deposit product that regulators decided to define and Congress has actually codified into law. Broker deposits are just basically any deposit that comes through a deposit broker.

So it’s not really the deposit itself. It’s really about how the law says how it gets into the bank and who qualifies now as a deposit broker. So in 1989, if you want to go all the way back to I’m about to be born, a deposit broker is any person who’s engaged in the business of placing or facilitating the placement of a deposit or an agent or trustee who establishes a deposit account to facilitate a business arrangement.

In 1989, what that looked like was businessmen, I assume in really big suits with shoulders, calling up on the telephone bankers and being I’ve got $4 million from a car, a car salesman, what rate can you give me? And then they would quote them. And that was a broker deposit. Often these would be certificates of deposit.

And so there was some rate competition and these would be pretty big accounts. Now, regulators decided to make this their problem and Congress decided to make this their problem because they were concerned that these types of deposits were particularly susceptible to risky practices. So what they found in the savings and loan crisis, and also again, in the great financial crisis is that using and growing broker deposit concentrations can be an indicator of higher risk appetites on the part of bank management and not banks that would fail with higher levels of broker deposits were more expensive to the deposit insurance fund when they failed.

And then broker deposit concentrations were correlated with higher levels of asset growth, higher levels of non-performing loans, and a lower proportion of core deposit funding, which all contribute to a higher likelihood of deposit failures or bank failures. And then, so why banks now have to care about this is there are regulatory and like legal restrictions of their usage based on bank capital levels. So if you are well-capitalized, there’s no issues.

If you’re adequately capitalized, you need to talk to your regulator. If you’re less than well-capitalized, you’re prohibited. And because the regulator doesn’t want you loading up on deposits, if you’re troubled.

And then what can happen though, is as a bank’s capital levels fall at a certain threshold, they’ll cross into under-capitalized and then all those deposits just have to be rolled off. And then that precipitates a deposit run, which we’ve seen. And so Jason, this is so exciting because I’ve never talked to a deposit broker, but it sounds like, I think in a past life, you were a deposit broker, right? You were facilitating the placement of deposits? I might not be wearing the cool suit, but I am wearing a vintage Perk Street shirt.

And Perk Street, believe it or not, was in the business of deposit brokering. And little did we know, inadvertently kicking off the banking as a service revolution, that now 85% of banks, according to the Finaster survey, say that’s how they’re going to gather deposits. So interestingly enough, building on why are broker deposits dangerous, it’s kind of that law of perverse incentives, right? Of if I have to pay more for my deposit, I’m going to do riskier things typically to get paid more in order to cover that.

Now, I learned the hard way back when I was working for a very large private student loan company, getting them into the banking business, because they were doing about a billion dollars of private student loans on their own book using a warehouse line from a bank. When the CFO said, why don’t we just become the bank? Jason, go make us a bank. Life-changing for me, right? Anybody know what section 38 of the Federal Deposit Insurance Act covers? Fun stuff to go read.

Turns out there’s also a max rate that you can actually provide as interest. I think we’re all familiar with the fact that usury laws, which vary state by state, are the max interest you can charge on a loan. But there also is a max rate that you can give out on your deposit depending on your capitalization level.

Because much like the broker deposit, if you’re willing to pay a lot more money, what are you doing with those deposits that are going to help you raise? This actually was part of the idea behind Perk Street, which I think a lot of you know, Dan O’Malley and I co-founded this idea that, hey, we could create a high rewards debit card that reward people with cashback rewards in the way that most credit cards did, but we’re going to do it on a debit card because that promoted more responsibility. We just needed to figure out a way, how do you actually fund that? We had this idea that these core checking accounts, and we’ll get into the definition of core, I suspect in a minute here, Kia, but these checking accounts are very stable balances. The problem is if you look at community banks, which 2008, the majority of banks were still community banks with a few of the large money centers and some regionals, but you reach stasis because you’re dependent on your branch network in order to bring those deposits in.

Before Simple, this idea of banking from your phone and opening an account like Wickety Split, even us as an online-only institution, some mail had to go back and forth related to the KYC, no. The idea was we thought community banks were some of the best at doing the small business lending, but they were deposit starved. If we structured things the right way, these could actually count as a non-brokered deposit on their books that they would be able to lend against.

Because for the most part, we went after the prepaid banks where instead of getting paid for the deposit, the program manager actually had to pay the bank behind them. Those deposits would just sit in an account. They weren’t being lent against.

That’s why you had to pay the bank to store it in that digital safety deposit box. We went to the bank corp first and said, hey, you’re big in the prepaid business. We see you could use more deposits that aren’t brokered deposits.

If we structure it the right way, those could actually be something that you could go lend against. There’s the history of Section 38. Alex, I want to hand it off to you.

What does this all have to do with banking as a service? Well, that’s a great question. The concern or the question, since brokered deposits evolved well before our modern FinTech era and were created, I mean, Kia, as you were describing it, it almost sounded like this very analog equivalent to what a nerd wallet or a bank rate does. Helping people who have a lot of excess money find the best place to put it.

Obviously, there are risks associated with those depositors, because they’re yield hungry and are looking for a good rate. In modern parlance, they’re usually well over the FDIC insurance cap. The companies that are shopping those things around, it’s coming from these very concentrated sources or these brokers.

In a Bass context, I think the really interesting discussion, and there’s been some regulatory changes over this, Kia, maybe you can walk us through is, are Bass deposits, so deposits that come to Bass Banks through their FinTech partners, are those brokered deposits? I think, Kia, walk us through the history of how regulators have looked at that question, because I think that sits at the root of all of those. Yeah. I just want to say real quick, I did a blend of the OCC, Chipotle, and KYC-ONO, and I’m sweating a little bit, so this doesn’t bode well for when I crack open my ghost partner, or my bank partner ghosted me.

I poured a little too much of the KYC on because of a little KYC is good, a lot of KYC is better, and my nose is running, so you’re in good company. Mine is too. You might be able to hear it while I’m speaking.

What happens in Hostod Frank is banks are doing some of these nascent FinTech partnerships, and we would see in on the call report, a growth in deposits, and sometimes it would be non-brokered deposits, which is how these deposits are reported on the call report, and then there would be one year, I think it was 2015, fourth quarter, just $4 billion of broker deposits were reported, and there was not a subsequent increase in total deposits, so there was a reclassification. It’s because at that point, the FDIC came out and said, well, these prepaid card arrangements that are maybe gift cards, maybe they are a FinTech partnership that is using the prepaid card technology, well, those are brokered because they come from a broker, and we have no more questions. We don’t really care about the rate.

We don’t really care about the type of customer you’re booking. We don’t really care about how much money is being moved. They’re just straight brokered, and a lot of people told me at the time, we don’t think of this money as brokered, and I think what they were saying is we don’t think of this money as hot, and we are not using it in the same way that we would use a brokered CD, and so that was going on back and forth, and then in 2020, which everyone misses because there was something else going on in 2020, I just can’t remember, but the Jelena McWilliams, the FDIC chair, she expanded one of the nine exceptions for a broker deposit, which is called the primary purpose exception, to basically stipulate that companies that aren’t in the quote-unquote business of placing deposits, like they don’t make most of their money shopping around their customers’ money, they do something else.

They just want to put the money somewhere, and then that’s it. They aren’t deposit brokers, and so it gave some FinTechs a little bit more leeway to say that we’re not deposit brokers. We’ll just put our money at a bank, and then that bank doesn’t have to classify those deposits as brokered.

Now, there is a list of companies that you can check to see who was asked for the FinTech or the third-party company to be listed as a primary purpose exception, and so you’d be really curious to see what well-known FinTech companies have applied to be on that list, and if their bank partner is the one that applied, or if they applied. That’s the 2020 change. Well, and there’s a couple of parts to this, right? This is what worries me for Baz broadly as a result of Silicon Valley Bank, which is the reason rate was important before is you shop the rate, and the likelihood someone else is going to pay you more goes up and up and up.

It’s an arms race for how much I have to pay to keep those deposits on hand. There is an analog in banking as a service when there were two handfuls of banks doing it well, that it invested the infrastructure, right? So, Bancorp and MetaBank ended up being the penalty boxes we talked about. A handful of other banks came along, they invested the infrastructure, built out dedicated teams, just didn’t try and run it off the side of their existing compliance desk, but actually built a practice around this.

Okay, when there’s a handful of players, you pick who’s the best partner for me, but when everybody is jumping in, it might not be the rate you’re getting paid, but now I can go shop partners, right? And the rate that I’m going to get, there really are only three potential components to the business model of the neobank. Interchange, which neobanks cannot live on alone, a share of the core deposits, and fees, right? And so, you got the interchange, only so much to go around, fees, a lot of the neobanks don’t like to charge because that’s what they’re competing on is banks are evil. And so, now you’re back to one of the key levers of already stress unit economics.

I think that’s going to be under pressure because if regulators were leaning towards brokered before, I think they’re going to lean even more heavily into it now. I also think with the rise of middleware or the best platforms, that could bring back into the broker deposit designation that if these platforms are just sprinkling around the deposits, it’s not really that kind of relationship that you could have argued some of these, the original Bass Banks or the early Bass Banks could say, this is a big financial relationship we have with this FinTech partner, and they’re putting all of their deposits with us. And this is a very core relationship, part of their business.

I think when those relationships change, you might get some potential need to reclassify some of the deposits you might get from a platform versus directly from your FinTech partner. And to that point, to use a specific example, Treasury Prime just rolled out a new feature of their Bass platform. And basically, what it does is it allows for the FinTechs operating on their platform to more seamlessly move from one bank to another, or in some cases, to build from day one multi-bank products that don’t necessarily rely on like, OK, we’re doing this product, all of these accounts at this bank, you can now design things across their networking banks.

So Kia, to your point, it goes from being something that’s very much of a like, we negotiated this relationship, we built an integration directly with this bank, all of that is really sticky, it would be really hard for us to- Right, it’d be hard to transfer the money. Yeah, like it’d just be really like operationally painful to move from one partner bank to another, which means from the partner bank’s perspective, they can argue, this really isn’t a broker deposit, this is like a sticky kind of core deposits, not hot money. But with all of this new infrastructure that’s being built, it’s much, much easier to switch between banks.

And so kind of, Jason, to your point, the point of competition within Bass, because we have all of these providers, we have all the supply in the banking as a service space, and all of it is much more fungible thanks to these banking as a service platforms. Now, things like rates and pricing and all of these other sort of things that were the characteristics that introduced risks, which caused people to classify them as broker deposits, all those things start to seep back in. The other thing that I’m curious about is, and Kia, I don’t know exactly how regulars have sort of thought about this or looked at this in the past, but the other thing that I think is really important is with the original sort of definition of broker deposits, you can make a pretty safe assumption that the only end customers that were working with brokers were people who were naturally like price sensitive and looking for like possible return.

FinTech companies are different though, because FinTech companies, even though they are as functionally brokering deposits for their partner banks, their value proposition to their end customers isn’t always about rate. And so if you were to look at someone, just pick on an example like Chime, I don’t think you can really make the argument that Chime’s customer base is like hot money that’s always trying to look for the best place. Their value is much more about low to no fees, about better overdraft protection, about credit builder products, about early access to your deposits.

It’s all of those features of the bank account. And the fact that they’re gathering deposits is really has nothing to do with like the price that they’re offering. In fact, they don’t offer a good price, right? And so- Oh, but Alex, I want to push on that.

Sorry to jump in, but Chime itself is rate sensitive because they need to make their business model work. So it’s worse than actually your customers not being rate sensitive is their whatever billion dollars in deposits that are sitting across some several banks, suddenly they can move those in mass faster than the humans can. Right.

No, that’s true, right? So it’s a different way of thinking about like concentration risk fundamentally, right? And that I think is what we saw with SBB and with all of the concerns we’ve had about sort of deposit concentration is it’s really more a question of if a customer decides to leave, if a customer decides to move their money, what portion of your overall deposits is at risk, right? And if you’re a money center bank that has tens of millions of retail deposit customers, one customer leaving is not a problem. If you’re concentrated among entities, whatever those are that can move a massive amount of your deposits overnight, that’s like inherent deposit concentration risk. I think one thing that I have been really interested in broker deposit is that for decades, the broker deposit designation has been a proxy for risk.

Like it’s just a riskier form of money. And then technology in 10 years completely changed some of these deposit characteristics. And so it’s almost diffusing the risk characteristics that we saw so concentrated in a broker deposit that Alex, to your point, if I’m a partner bank on a treasury prime platform, do I need to be thinking about the deposits I get from treasury prime as being slightly riskier to moving if treasury primes FinTech client moves that? And if so, how do I account for that given that they’re low cost deposits and given that these are transaction accounts that are really small? It is changing, I think, a lot of the calculus.

And we’re kind of seeing some of those deposit characters come up in Silvergate or come up in SVB. Well, building on the SVB portion of it, is our designation of a lot of these characteristics broken relative to how the money moves? Like look at the money that was hung up by payroll processors that was well over the FDIC limit. The money was never meant to be there for very long, right? It came out on a Thursday, is meant to leave on Monday.

Do we need to rethink our structure, period? Yeah, I mean, I think that’s the exact right question to ask. And I mean, I know we’ve had lots of discussions in the wake of SVB about what’s the right amount of deposit insurance coverage for different types of accounts. And I think there’s a portion of that discussion, but more fundamentally, Jason, to your point, the underlying infrastructure for what these accounts are enabling is just vastly different than it used to be, right? And so there’s just so many different parties involved in it.

I mean, it goes back to something I know you and I talked about a while ago, which is when the acting comptroller of the OCC is talking about categorizing different types of fintech companies and trying to get your arms around like all the different flavors of fintech that are out there. To me, that’s like part and parcel of this problem, right? Is you can’t treat broker deposits as like one big designation, and you can’t think about deposit risk as just being like, oh, we have these three categories, and they get reported on the call reports. We can just sort of keep our finger on the pulse by looking at that, and any red flags will appear.

Like you have to have a much more nuanced and granular view of what all the banks are doing, because I honestly do think some of these relationships from like a fintech fast perspective are actually very low risk, right? Like I think they aren’t particularly hot deposits. I think there are definitely examples where that’s not the case, but increasingly, a lot of it is very, very hot or risky or very concentrated. And in those cases, you want to be able to sort of separate those things very carefully, not just lump everything together.

Yeah. And I was surprised to learn this morning, Alex, that you did not consider Silvergate to be a Bass Bank, but I guess, sorry to put you on blast like that. That was in the DMs.

But from me, Silvergate, no customer opened an account at Silvergate. They opened an account at Coinbase, and Coinbase put their money at Silvergate. And so from a bank perspective, that’s kind of like that deposit broker.

Coinbase is a company that’s on the primary purpose exemption. Therefore, thereby, for me, Silvergate had these Bass characteristics, and we had basically a Bass deposit run because all of Coinbase’s customers pulled their money, and Silvergate, which was overly exposed to one of its fintech partners, had that. And I don’t know if actually if Bass Banks look at that and are like, well, that’s just Silvergate’s problem.

That’s their one customer problem. Or if they’re thinking about the vulnerability and the deposit concentration to their large fintech partners as something that’s just a risk that needs to be managed. And I think bankers are very good at thinking about broker deposit, quote unquote, as being risky and having those conversations.

And I think the conversation now needs to evolve since we’re seeing liquidity have different risk characteristics under different circumstances. Yeah. I mean, so to defend the other side of that argument, since you- No, you were wrong.

You’re just straight wrong. Go on. I’ll entertain it.

Well, I appreciate that. The thing I was thinking about it more was mechanically, right, in terms of the way I typically think about banking as a service is the company that’s with the bank is borrowing their charter in order to directly offer banking services. And crypto makes it a little bit different, right? Because the exchange’s relationship with the customer was, we’re going to help you buy crypto.

And they were executing that part of it themselves, right? And so Silvergate was more just a bank account that they could put all of the money they got from their customers there. So it’s not Bass the way I typically think about it mechanically, but I think your point is a good one. It is a different form of this brokered deposit, concentrated deposit risk, which is Silvergate was basically exposed to, if something happens in the crypto ecosystem that affects the 10 largest crypto exchanges, and I’m just making up a number, I don’t remember exactly what it was, 80% of our deposits vanish, right? And that’s a problem.

And so I think that they certainly meet the qualification of brokered deposit the way that it was originally meant to convey risk. And I think the other thing that’s interesting that you touched on when you were describing sort of the origins of brokered deposits, and this is, I think, really interesting is as it relates to brokered deposits, the question was really, why is this bank going out and collecting all of these deposits? What are they going to do with those deposits that we should be scared about, right? Like if they’re out and doing this, then they must have some plan to earn yield on all of these liabilities that are sitting on their balance sheet. That I think is maybe not quite the same today as it was before.

Maybe that’s just because of the brokered deposit rule. Oh, no, this is my new favorite thing. So brokered deposits that are CDs, so certificates as deposits, are duration-based deposits, and they’re basically like a bond.

They’re like a customer bond. And so it’s been so interesting to banks for the last year raise a lot of brokered CDs. And the reason why is because not only are these duration-based locked in rate, so you kind of get a hedging at higher rates, these are difficult deposits to leave the bank.

And so by paying up on the higher rate, banks have been, they take on the other side, like you can’t pull your money unless obviously the bank becomes less and less capitalized. And so arguably, broker deposits today might be less hot than potentially an uninsured large operating account that would pull itself out. And so I think that, again, back to that more nuanced, more updated technology-driven rate-based analysis, banks might, broker deposits might become hot or of interest again, because they’re seen as less hot than a different type of funding.

This show is brought to you by Alloy Labs. As much as we love talking on the show, we believe that action is more valuable than talk. Alloy Labs is the industry leader in helping fearless bankers drive exponential growth through collaboration, exclusive partnerships, and powerful network effects that give them an unfair advantage.

Learn more at AlloyLabs.com. Alloy Labs, banking unbound. So for everyone out there who was, you know, influencing on Twitter or on LinkedIn, that how come Silicon Valley Bank didn’t actually, you know, how’d they end up in this position that the deposits, you know, could be pulled at any point, because it is called the demand account, versus they were in a lot of these assets that had a five to seven-year duration. Frank Rotman from QED wrote a great piece on, you know, the business of banking is really one of duration transformation, right? That you inherently, no one wants to go take out a mortgage that could be called due tomorrow, right? Like, not a great way to finance your house.

And that’s what banks were set up to do, and this is why regulation and all of the caps around, you know, how much liquidity do you need to have? And, you know, all of this went into it meant to be safe and sound. But inadvertently now, like, we’re in a space as we’ve seen rates go up as if everyone was acting like it could never go up. Oh, no, everyone.

Kia is taking it up to 11. My bank partner goes to- Also, I want you to know that this is the one bottle that didn’t come with a little dropper. And so I have now like a pile of ghost pepper hot sauce on my plate.

That was an unexpected surprise. Yes. Things are going to get hot.

I would love to know, for those not watching the video, Kia and I are sweating profusely here. And Alex is just a little bit of a shimmer. Okay, wait, Alex, do you get red? Like go to the well, like Kia and I have literally mopping our heads.

I get red cheeks, so you’ll see it come soon. Okay. All right.

So if we’re in the, you know, duration transformation business is the core of banking. And concentration is an issue there, right, where a small change in a sector or a big change in a single sector can blow up your business. Oh, Alex is now flinching and beginning to sweat.

Oh, it’s so hot. It’s so, so hot. But if we’re in that business, how do you actually begin to control for it? Because the flip side, and I know I’m talking out of both sides of my mouth here, it’s like saying, hey, Baz is not the answer, you know, in terms of the business model, because it’s lumpy.

But Baz is a good way to actually, without having to manage the business yourself, say I’m going to create a well-diversified set of fintech partnerships that, yeah, Alex, pick it up from there. You got it. Yeah, this is my jam, right? So like I, and Kia, I think maybe you can argue the other side of this, but I, because I think I texted you about this before I wrote it in my newsletter.

But to me, banking as a service presents a really interesting way, broadly speaking, to like transform the way that we manage deposit risk on one side versus like the business of really closely serving customers on the other side, right? So like one critique I think you could have of Silicon Valley Bank is that they were a really good fintech company in the sense that they were really close to their core customer base. They were entirely focused on that customer base. They passed on opportunities to make revenue in order to serve those customers better.

Kia, as you know very well. That’s the kind of bank I want to bank with is the bank that’s willing to make a little bit less money so they can serve me better as a customer. Like international wire transfers.

No problem. We’ll give those to you for free. Oh, like you’re having a meeting and you want to do it at like a cool venue.

Do you need a ski chalet? We’ve got one in Lake Tahoe. Are you available next weekend? To us at Alloy Labs, I’d just like to be clear, I am a little upset about it. Wow.

Were you so mad to learn that other customers got a ski chalet? Regular bank, you’re like ski chalets? What is happening right now? That’s awesome. So I mean, I think that that is a value that SVB sort of demonstrated in the market, right? Is that businesses and consumers want banking partners that like understand them and are like very narrowly focused on serving them. But the problem as we’ve been sort of talking about over the last couple of weeks is SVB’s concentration and focus on that customer segment created a very brittle balance sheet on the back end.

And so I do sort of wonder hypothetically, like what if banking as a service essentially functioned to provide diversified balance sheets on the back ends of very, very hyper-focused and niche customer solutions on the front end. And I think that’s an interesting way to sort of conceptualize this new environment that we’re living in where deposits can move around all the time and like nothing is quite as sticky as it used to be. I mean, another thing that’s just interesting about this broker deposits discussion is all of this existed before the idea of anyone being able to look up rates whenever they wanted, right? And even something like, you think about what the CFPB is trying to bring to life with 1033 and with open banking, they want to create a more competitive, more portable banking environment, right? It’s like, you should be able to switch your bank with the push of a button, no problem, no one gets trapped at the bank that they don’t like anymore.

Well, if we take that to its logical conclusion, pushing a button, as soon as you get a notification that there’s a better rate out there, suddenly all money in financial services becomes hot almost by default, right? So I think we are sort of marching thanks to technology towards a future where this like managing between core and non-core deposits or broker deposits of non-broker deposits that might not make sense anymore. So I just dipped into the ghost pepper again for my bank partner ghosted me. And so if I just fall out of my chair while saying this, this is going to be the spiciest take I’d love to hear from you.

Is the business of banking broken? Because I look at this business model, if we are dependent upon these fintechs that Simon Taylor wrote this great piece around the business model that if you don’t read his sub stack, you probably should. Although I think everyone who listens to this podcast probably reads it. If we can’t have venture money subsidizing the unit economics of a lot of these fintechs that in turn, we’re allowing them to place deposits with banks for the things they couldn’t do themselves.

Like at some point, like this train has to end without the VC, like how are we going to make money? And I’d say that is both for the fintech and the bank, if that’s how you’re gathering your deposits, is your bank broken? So I guess I as the bank person should probably respond. I think technology is changing banking in a lot of different ways. And I think banks have always seen technology as something that augments their business and have maybe, I think we’ve moved away from fintechs being outright competitors.

Now they’re trying to work with banks and have banks as customers. But I think we need to be really aware of and update our assumptions for how technology makes it easy to move money and respond to that. Alex, when you were talking about SVB, I was just like, okay, so it sounds like he’s arguing for deposit diversification.

He wants SVB to be a bass for some other regional bank. And I was just like, they could just have some different deposits. Other things.

I mean, that was kind of the sort of existential question that SVB seemed to struggle with over the last, like really like 20 years in particular was like, should we diversify? Should we get into like other types of lending? Well, why don’t we lend to like vineyards? And you’re like, oh, well, actually it’s not at all because it’s all the same. Not diversified. Yeah.

Not diversified. Like diversified would be, we’re going to be Silicon Valley bank, but we also have a sneaky business that we don’t talk about where we take deposits from, you know, family farms in Iowa, like that. So I remember when, um, I think CIT was acquired by first, uh, first citizens, which is also now our buyer of SVB.

They talked about HOA deposits. Do you guys remember being like, I’ve never thought about HOA money in my life. And apparently that is very, those are big accounts and they’re very stable because HOAs have, they have to like keep a certain amount in escrow.

And I learned all about this deposit. And they were basically like, the only thing you need to know about these deposits is they are lazy money relationship based and HOAs really want to work with someone who knows about how to work with HOAs. And so we want to buy this HOA business.

And I don’t think banking is broken, but I think like the, I’ve always been so fascinated quarter after quarter hearing banks talk about their deposit betas. And it’s just like, man, you’re going to have, those are going to have to rise sometime. You’d rather increase your beta than have the deposit leave, right? Like I don’t know how banks are going to have to update their deposit strategies, but for the last year I’ve been writing that they need to be doing it.

They need to figure out what’s important to their borrowers and depositors. What’s the value proposition. Do you, you know, do people keep money in the bank to get certain services for free? Um, and under what circumstance, who’s competing for this money, you know? Yeah, no, I, I totally agree with what you just said.

I mean, like, and Jason, I think she hit the hot button for you too on like, what’s the value proposition for keeping the money at the bank, right? Like that’s the, that is the whole sort of question. And I think there was a certain amount of like laziness that just crept into banking over the last couple of decades of just like, oh, well, they’re keeping their money here because they like us or because like, we won’t say this out loud, but they really don’t have any other choice. Right.

And like now they have other choices and it’s very obvious banks that are sort of labby in terms of like, well, like what is your value proposition to your customers? I was really surprised when I was reviewing a bunch of the sort of bigger banks earnings calls over the kind of the beginning of this year and looking into the 2023, a lot of them were very, very confident that they were going to be able to keep their betas really low. Right. And I think when sort of smaller community banks or regional banks, look at that, they go, they take the wrong lesson from it almost, which is like, oh, we’ll just, you know, do what the big banks are doing and just sort of like keep the betas low and just hope that customers are noticing.

And I actually think that’s like a misunderstanding of what big, bigger banks are doing, which is they are providing a money center, right? They are providing a whole ecosystem in which to interact, where it makes sense for people to keep their money there. It’s not rate seeking behavior. And so it’s not just like, oh, we kept our betas low because we really like tighten the screws on our depositors.

It’s we understood what our depositors come to us for. And we knew that meant we wouldn’t have to raise rates quite as quickly. And so I do think the middle of the sort of banking ecosystem needs to sort of relearn some of those lessons.

Yeah. And you know, that’s one of my hot buttons here, Alex, related to, I feel like I’ve been chicken little wandering in the wilderness for a while saying, hey, what’s your deposit strategy for the last 10 years? They’re like, we don’t have a deposit problem. You know, federal funds are zero.

And my customers love us. They would never go move right up until they all move. Your customers are fickle that way.

And even the banks you speak to and say, oh, we’re more of a small business or commercial bank, they forget in Frank’s piece, unless you actually have those low cost sticky deposits coming in one hand, you do not have the right and the ability to lend to those small businesses at a competitive rate. And by and large, it is the consumer accounts that tend to be the stickiest, the average in a checking account being, you know, just over $1,200. And like key is a choice, like it’s your expenses tend to be relatively consistent.

So you keep a relative same amount, you know, varies, you know, week to week within the month, but it’s pretty stable amount. Yeah, I was, I was wondering if after the, the Jason, you did great. No one could tell that you were dying.

You can go on mute now. Oh my God. I’d like swallowed like pepper that was stuck in my tooth.

I was wondering now if there’s actually going to be greater emphasis on retail deposits, greater competition. I wonder what that will look like. If it’s going to be branch-based, if it’s going to be, you know, trying to get people to move their direct deposits, just make retail money.

Like there’s a greater emphasis on getting that or not losing that money. And so, yeah, I do think that these deposit strategies and just kind of like having a plan, that’s just so important for banks. And also for me to think like under what circumstances and how much money can we have leave a day? And how would we replace that money? Right.

So like, that’s, that’s a big, like, that’s why we care about this is, is avoiding that the deposit run. Yeah. I mean, the, the competition for retail deposits to me is a really interesting question because you sort of have to think about, and we saw this, right.

When rates were low, one of the competitive levers that FinTechs were using was we’ll do high yield savings accounts. Right. So that was, that was like a way that FinTech was sort of trying to differentiate itself from banks.

But, you know, I think that even within the retail banking group, there’s some sort of hot deposits that you can sort of lure around with rates. And then there’s lots that are just not responsive at all to rates. And so if you’re going to compete for customers in the retail deposit space, how are you competing? Right.

I mean, I don’t think you probably want to compete with rates because then you’re not really solving your problem. You do want to try to compete for that direct deposit, but like kind of goes to sort of these existential questions about like, what is the purpose of a deposit account? What’s the like core job that it’s supposed to be doing? I wrote a piece in my newsletter a while ago about like different constructs for how we could think about building retail or consumer bank accounts. Right.

On the premise that bank accounts are sort of generically optimized to not do anything particularly well, but like, you know, if I had a bank account that, you know, as an example, just helped me really do a much better job managing all of my bill payment. And it was sort of my bill payment command center in a way that most bank accounts are not really designed to do, even if they might do a little bit of bill payment, like that would be a nice thing to have. And that would give me a very sticky reason, not at all related to rates to keep most of my money in my direct deposit pointed in that direction.

But the product design has really lagged this concern because Jason, to your point, rates have been really low and we haven’t had to worry about it. Well, and this goes back to the Ron Shavlin ism of what he calls community FinTech, right around, you know, whether it is a community or a specific set of features, but hopefully now that the venture capital money is free, heyday is done. We’ll see some meaningful work there as opposed to, you know, the bank for left-handed people.

Although I do think we need a bank for people who love hot sauce and hot takes, you know, pay pays in, you know, sauce, not in interest. Yeah. You can like convert your direct deposit just directly into bottles of hot sauce.

So it does raise like the question as we do bring this to close is can banks and FinTechs adapt fast enough to where this new world order is going? Because to me, the, with what happened, you know, to three banks in very short order, just as the proof point that has taken too long to come and probably needed to be this level of severity, because like the frog in the boiling water, I think is an industry that we’re so slow moving, both FinTech and bank sometimes that we didn’t see infrastructure has changed. The players have changed. The business models are now under different pressure.

The question is who’s going to be able to survive both if their burn rate’s high enough or the bank that needs to adapt fast enough. You know, for banking, we went from the hot, the environment is a high rate environment and we’re worried about deposit betas too. Customers are worried about money and we need to reassure them that their money’s safe.

I, you know, it’s hard to think like, it’s hard to have bandwidth about innovation and adapt, you know, adaptation at this point. But I do think that as, or I hope that as banks are thinking about how they can show customers their money is safe. Our bank is diversified.

We have liquidity facilities. We have a bunch of uninsured, or we have a bunch of insured deposits that aren’t going to pull, you know, then you can start thinking more creatively about value proposition, diversification, the risk and their deposits. Maybe, maybe they do want to do a high, you know, high rate savings account.

We’ve talked, we haven’t even talked about this, but New York community is now the bank partner of HM Bradley. And they are, they offer a high yield savings. And it’s interesting to see a FinTech choose a bank above 10 billion.

And maybe we’re getting away a little bit from the emphasis on interchange. And as we see New York community has an aggressive deposit strategy that includes acquiring signature, right? And New York community has been trying to change their deposit base for like about 10 years and how they get funded. And they’ve just done two very interesting moves to diversify their, their base.

So I think hopefully we’re, we’re getting away from is my money safe to how can I make sure my bank funding is stable and diversified and really like people feel like they get value from us. What do you think Alex? Yeah. I mean, I, so building off of that, I’m glad you brought up HM Bradley.

Cause the other thing that they announced at the same time as the move to a new partner bank was their partnership with thought machine for a new sort of core banking and account ledger system. And they had been using the one that they had from their old partner bank hatch which was sort of more of your typical legacy core banking system that was batch based. It was not very flexible.

And, you know, I think that move is actually one of those things that might end up being kind of a turning point for the whole industry. I mean, when I think about sort of what all this means for FinTech, my, the first thing I’ve jumped to is all of the ledgers that are being used to manage these FBO accountants and these like sort of relationships between the FinTechs and their banking partners. I mean, I personally, as you know, just sort of an observer of the industry, I would like to know what all of those ledgers are, how well they work, how often they’re updated, how resilient they are, who manages them, who’s responsible for that.

And I actually do think that that will become a point of regulatory focus and clarity because that’s that bridge that sits in between all of these complex relationships. And there were some folks who were kind of speculating after the SVB failure, like what would happen in the reverse of a FinTech company failing but the underlying bank being okay. And so much of it is dependent on that core system, being able to help navigate through that challenge and make sure that if it’s the FDIC and they’re working with them, that they know whose money is going to who.

And to me, there’s just a huge amount of like upgrades and sort of just infrastructure improvements and more oversight of that particular corner of the sort of bank FinTech world. Yeah. The first Bass Bank that fails, the FDIC is going to be like, oh my God, someone please buy, someone take these deposits from us, please.

We don’t know. Well, Key, as long as you want to pick on me and call me a deposit broker, let me tell you is I think we were the first Bass Bank to fail for Perk Street. But when the acquisition we had been pursuing fell through, it became a really interesting point.

I think this, we’re going to find more of this push from regulators to the banks is this had never happened before. And we had a bunch of VCs who also looked at this and said, well, okay, just shut it down. It’s like, we can’t just shut it down.

It’s like, but you’re out of money. It’s like, yeah, but we can’t because we’re how people actually pay their bills and they’re dependent on this card. We have to get that money to them.

And so we had to operate as a zombie and work with our two bank partners to get it to the finish line in an orderly fashion. Sounds like you need a living will is what I’m hearing. That’s a resolution plan that you hand to the FDIC and are like, it’s all you, buddy.

I don’t know if you read my piece around the living will, but everyone in the heyday said, oh, you can always just raise more money. Well, you can’t always just raise more money. I think it’s clear now, not only can you not always raise more money, there are a lot of challenger banks and other fintechs out there that have unit economics that can never be fixed.

Well, and the problem is from more of a cultural standpoint, fintech founders are optimists, which I love about them, but they don’t go into these things thinking like, what happens if we fail? What’s the contingency? What does our living will look like? And if you were to talk to your VCs about like, yeah, we’re spending some cycles figuring out what happens if we fail, the VCs would flip out and be like, we’re not paying you to do that. Go figure out how you’re going to be successful. So I do think there is a fundamental mismatch between the incentives that venture backed fintech companies have and the prudence that you want to see from banks thinking through those contingencies.

So let’s end it on prudence, because I don’t think any of us exercise any prudence in the amount of hot sauce that was consumed here. But thanks for taking the time to come spice things up on everyone’s favorite topics, core deposits, are they hot or not? Thanks so much, Jason. And thanks so much for this hot sauce.

My face is going to hate me for the rest of the day. Yeah, I don’t think I’m going to be able to swallow for the next little bit, but really interesting topic. I personally think core deposits are hot and getting hotter all the time.

How are we voting? Oh, I’m sorry, I didn’t vote. I have so many thoughts about, okay, uninsured deposits, hot right now. Time deposits, not hot.

Broker deposits, not hot. Any sort of deposit promotion strategy, hopefully not hot. I’d love to see some banks in a quarter or two.

Bass, I think fintech deposits are not hot. And then high rate money, as someone who has a high rate account, would I move it? It would have to be like a big delta. It’d have to be more than 50 basis points higher, but that would be hot.

Okay. Right now though, the way funding is working is, I think anytime you can lock up money, that’s not hot. That’s the most important thing is can you lock it up? Can the money move? I think right now I’m leaning more towards money movement rather than rate as the predictor of hotness.

Just because if you think about treasuries, like if I can buy the world’s safest bond instrument for 5%, you can’t tell me that the rate is predictor. I also think that increasingly banks are going to have to think about deposit growth as being a risk factor rather than the rate paid on the deposit. Silicon Valley Bank, lots of non-interest bearing deposits, high growth rate, big risk.

And then big asset liability management issue coming up there. All the banks are fine. Just tell the FDIC that I said it’s fine for a lot of deposit.

Well, as long as we’re going the hot or not right now, I think do nothing as a strategy is so not hot. I think there are going to be a lot of fintechs and banks that continue to do the same as the same has worked or that go back to the old playbook that says in a recession, it’s about flight to quality of your lending, work out early and often and trim expenses. I think that is also not hot.

They’re going to land themselves in trouble because the world is moving faster. What I do think is hot is since you brought up HM Bradley, I think what Zach has built is one of the few fintechs you can look at and say, fundamentally, rethought the business model on how to make that work, and that’s why they’re winning. I think those who figure out new business models are hot right now.

I would say, from the banking perspective, those banks out there looking at how do I grow my deposits in a non-rate-based way, but it’s about value contribution? How do I build an ecosystem? I can’t do it at scale like the money centers do. Don’t just try and play a money center bank strategy at subscale. What ecosystem can I go build out? That is a hot play if you’re a banker right now.

Alex? I agree. No, I agree with everything. Yeah, the smart people have spoken.

I agree. Alex, did I change your mind about broker deposit regulation? Have I successfully done this? Can I drop this camera? I think you did. Yes.

For listeners, this started with Kia texting me, me going, I don’t think broker deposits are hot. She’s like, Alex, no. She texted an all-cast.

No, he said that. We were talking about Silvergate’s funding. I was talking about the broker deposit.

He’s like, I think these are good rules. I was like, no. She intervened.

Wrong. That was the wrong takeaway. I feel like that was the culmination of all my education on this topic.

Also, I would be interested, thinking about regulation, I personally think that the FFIEC needs to update the call report to break out some more information about deposits. I don’t think brokered and non-brokered or CDs are the most useful way to think about deposits. I would be interested in a line item around FinTech deposits or deposits that come from… We need to probably get more information about sweep accounts or other types of deposits that we just need to know a little bit more about the risk characteristics of them and the relationship, just because you need to know how the deposit could move.

The broker deposit designation is increasingly not useful in today’s technology. Once again, regulation lags what the actual reality of this ecosystem looks like. All right.

Thank you both for joining. That was hot. Way to finish.

Thank you for bringing it. That’s it for another week of the world’s number one FinTech podcast and radio show, Breaking Banks. This episode was produced by a US-based production team, including producer Lisbeth Severins, audio engineer Kevin Hirsham, with social media support from Carlo Navarra and Sylvie Johnson.

If you liked this episode, don’t forget to tweet it out or post it on your favorite social media, or leave us a five-star review on iTunes, Google Podcasts, Facebook, or wherever it is that you listen to our show. Those actions help other people find our podcast, and in return, that helps us build an audience that can be supported by sponsorship, so we can continue to provide you with our award-winning content every week. Thanks again for joining us.

We’ll see you on Breaking Banks next week.