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.

The FDIC recently proposed a rule change on how broker deposits are treated. This isn’t so much a proposed change, but a rollback, a roll way back, like way back to 1989 when the original broker deposit rule was written. As Jason McCoula points out in this episode, that’s when Taylor Swift was born.

Jason, Alex Johnson, Kia Haslett are always regulars when we’re doing some hot takes. And today, Alex Barrage of Trump and Pepper joins us. We have some really hot takes on the business of banking, and it’s really changed through the eras, and it’s got some big implications for the future.

So Kia’s bucket list item to record an entire episode of Breaking Banks on hot deposits a little over a year ago. Who knew we would be back again to talk about deposits, hot or not? Alex, you had no idea what you were signing up for, because I think that last episode traumatized you to begin with. But you also dropped a prescient bomb talking about FBO at the end of it.

I did. I did. I was very happy to re-listen to that episode, because this was March of 2023.

So yeah, I mean, it’s not like Bass wasn’t going through some stuff at the time, but Synapse had not blown up. And yet I did specifically call out ledgers and FBO accounts as an area that I was concerned about at the end of that podcast. So I will chalk that one up as a win.

And I learned more about brokered deposits just listening to you and Kia rant about it a year ago than I ever possibly could have imagined. So Kia, I’m curious, in retrospect, is there anything that you’re either surprised at, like, wow, how did we nail that, or that you wish we had made as a point, given the current market situation? Yeah. Well, one, I am really happy that I have increased my deposit nerd friends by about 200% since a year ago.

I think that’s really great growth. So there’s five of us now? There’s now five of us, at least five. I think there is maybe some people who would wish that they had been invited to this conversation, but maybe couldn’t get their hot sauces in order.

But when I went back to listen to the podcast, I became very concerned that I don’t think this happened, but that someone at the FDIC listened to our podcast and then got a bunch of ideas and then put them into a proposal that was slated for the July FDIC meeting. Because I think it was possible to take away from that conversation that because deposits have different characteristics and are risky, and the word hot got thrown around a lot, now we’ve got to deal with this. And so I was wondering what from that podcast could have maybe influenced anyone at the FDIC in maybe the way that we weren’t fully expecting to come back together to discuss this topic.

Yeah. Well, for those who have not listened to it, we’ll put it in the show notes, but what really started this cascade was at the collapse of SVB and First Republic was this idea of, hey, deposits perform in different ways, as Kia said. Where else do we see large numbers of uninsured deposits that are in tight communities that can move in very lumpy fashions? And we said, hey, banking as a service is actually a bit of a risk in something like that.

So I see Kia has broken into her hot sauce. So I’m going to load up. This was going to be such a spicy episode, I didn’t think that my bank partner ghosted me ghost pepper was going to be hot enough.

So I’ve also brought in the crybaby cry Craigs, as well as the personal kick my butt I’ll be on the couch for the rest of the day with a sore stomach. This was my Christmas present from someone who evidently does not like me. What are you eating today, Kia? So it’s 1030, which did impact my normal approach of getting wings.

So I got chicken minis from Chick-fil-A and the potato rounds. This is a potato product, but I think hash browns are better or tater tots are better than fries. I have two hot sauces from Jamaica.

I’ve got a scotch bonnet curry and a Jamaican red. I have the ghost pepper, but I fixed the bottle issue that we had last time. And I have your KYC, oh no.

I will say I finished the OCC Chipotle. And I do think that the next time you do this massive private order of hot sauce, you really do need to bring in the FDIC. I think the FDIC maybe got a little jealous that they had been left out of the hot deposit conversation.

So you should probably think about a nomenclature for them. So Alex, welcome to the crazy club that loves to nerd out on deposits. And I know when you received your hot sauces, you didn’t think you were actually going to be enlisted to eat hot sauce in a semi-public forum.

You’re welcome. I have them all here. Thank you.

It’s great to be here. I will also mention that on behalf of the FDIC, where I used to work, I was kind of sad to see that there was no FDIC hot sauce. Hot money sauce is a potential idea for that.

And I think it’s totally consistent with what we’re going to be talking about. So I will make do with what I have. Well, you will have to attend Finnovate, where in fact, one of the custom hot sauces that is coming out for the live episode that Kia, Chase, and Alex Barb and I are doing is these deposits are hot.

As a resident lawyer, why don’t we kick off with you on the first serious question, break down for us the proposed rule change around deposits. Okay, well, thanks again for having me on. I think the easiest way to characterize the proposal is that it’s a rollback.

It’s a rollback to a rule that existed before 2020. In 2020, the rule was modernized in part to reflect the deposit arrangements of today, including those that are associated with a lot of fintechs. And so I just want to dispel Kia’s fear, which is that, did you guys let the cat out of the bag and give the FDIC ideas? I don’t think so.

And the reason I say that, the reason I say that isn’t because FDIC folks don’t listen to podcasts. They do. And they probably listen to yours, which is good.

But I say that because I was present at that meeting in December 2020, when the broker deposit rule was finalized in its, let’s call it modernized form. And I share this story because I think it’s just kind of inside baseball, but it’s interesting. The meeting itself started with then chair Yelena McWilliams giving then board member Marty Gruenberg a plaque for the longest serving board member in FDIC history, an honor that I’m pretty sure he still holds.

And she gives him this plaque and the professional photographer comes in and pictures are taken. And it’s like this really nice kumbaya moment and staff are like, just feeling good, right? And then the agenda rolls and then it’s almost like the gloves came off. And the actual final rule, once it was on the agenda and it was discussed, then board member Marty Gruenberg’s dissent was, I think it was the longest dissent on record for any board member on any rule.

And I remember listening to it and it went, I think 20 minutes or so. And in that moment, I thought to myself, he really cares about this in a deep way. And I think part of that is because he was around during the SNL crisis and he was around on the Hill, most likely when FIREA was being discussed.

And so going back to your point, Kia, I think that this is something that’s always been on now Chairman Gruenberg’s radar for a while. The question was just like, when was it actually going to get slotted in? As you know, there were a few failures last year, right? So I don’t, and I listened to that podcast from last year, it was great. I don’t think it was the catalyst for what we saw a few weeks ago.

So what we saw, what we have been looking at is a proposal that is a rollback. And effectively what the proposal would do is do away with a lot of the, I’ll call it guardrails, bright lines that the 2020 rule actually sought to put in place, in part to give banks and non-banks some clarity. But also I think in some ways to allow people like me who advise those banks and non-banks to say, look, the facts matter, let me take a look at your product.

If you do it this way, you might trip matchmaking, be careful. But if you do it this way, based on this Q&A, you’re probably safe. And so both from kind of an industry perspective, but also a practitioner’s perspective, the last four years have been, in my view, greatly beneficial to the market.

I think one of the concerns that I and others have about this proposal is that there’s very little in the way of data and analysis on the actual deposits that we’re talking about. It’s almost like it’s an over, I think it is an overreaction to a problem that is largely an old problem. I’m not saying that volatility in deposits is something we shouldn’t be concerned about.

We absolutely should be concerned about it. But the proposal itself is almost just like a reflexive walk back to the past. Instead of really thinking about, well, let’s take a look at these deposit characteristics.

What’s risky about them? How many are there? How should we cohort them? And doing more of what I’ll call a thoughtful analysis. And so I think ultimately, and others will push back on me, please do, what this proposal represents in the broader landscape of what we’ve seen is kind of like a throttle to go forward and go back to the past. Instead of saying, hey, wait a second, we’ve got an RFI on deposits.

We’ve got this document that asks a lot of interesting questions about deposits and liquidity risk. We’ve got another joint federal banking agency RFI on bank FinTech arrangements, which cover these deposit arrangements. Why don’t we let that process run its course? Why don’t we let the industry and other stakeholders respond to the very same questions the agencies have thoughts about? And then to the extent anything in the broker deposit proposal needs to be tweaked, well, now we have the data.

To me, that is the most thoughtful and prudent way to proceed here. But that’s not what we got. Yeah, Jason, I know you have some strong thoughts on data and analysis related to this.

Yeah, I mean, first of all, I was shamed for my selection of Valentina as not being hot enough. So you’re just going to have a really nice podcast. You’re going to eat some like really nice, savory food.

I mean, I think you guys and some of the listeners probably know my better half is Mexican and keeps a stash of actual peppers. So this is homemade. He recycled the jar of salsa macho, which is extremely hot.

So I’m doing my best to bring the heat. Recipe will also be in the show notes along with the one that QED brought in. I will have to ask if the NDA applies to the recipe.

No, I mean, you know, I think at a high level, I, you know, completely agree with Alexandra and oddly enough, Chairman Travis Hill, it’s like the broker deposits framework does not feel fit for purpose. If the purpose is to understand the level of riskiness of certain types, certain kinds of deposits, right? At its highest level, it’s binary, right? Either this deposit is brokered. And if you’re less than well capitalized, either you need a waiver or you can’t use it.

And there’s certain def deposit insurance fund assessment differentials, or it’s not brokered in the reality. And I listened to Kia and Alex Johnson’s podcast this morning. You know, the reality is like these things don’t cleanly map one to one and board member Hill makes that clear in a statement.

If it wasn’t in the FDIC meeting, then it was at the comments he gave to the American Enterprise Institute about a week before. But it’s like, you can have broker deposits that have characteristics that are higher risk. You could also have certain kinds of broker deposits that have characteristics that are actually stickier and lower risk.

And to the point that Alexandra just made and that Kia made vociferously in the podcast, the Bank Nerd Corner podcast. So at this point, like we haven’t actually seen material data to inform how we’re going about making this decision. So yes, I co-sign, I co-sign these arguments.

Yeah, I had a conversation with a bank just yesterday talking about, you know, hot deposits all the time. And they have a partnership with Raisin, which are now being labeled as brokered. And they said they are actually stickier than, they’ve done the analysis, than a lot of their other deposits that are considered non-brokered.

Yeah, I think one of the things that is interesting is the proposal says that prior to the 2020 rule going into effect, you know, there was X amount of broker deposits in the industry. When the rule goes into effect, there was a reclassification of about $350 billion in broker deposits, like so a quarter over quarter change without maybe meaningful change of total deposits in the industry. Now, I think that’s really interesting because if you looked at today’s call reports or, you know, the FDIC quarterly profile, you’d see that broker deposits have been on the rise.

And you can probably assume that those are maybe brokered CDs or reciprocals that are above the exemption limit. And it’ll be, you know, one thing that will be interesting is to see if this rule goes into effect as proposed in these call reports or these deposits get reported as brokered to see how much the growth in the industry has been. And, you know, I was kind of struck by, you know, reading the 2019, the proposal for the 2020 rule, reading these RFIs, reading the brokered deposit rule proposal to kind of say, like, is this actually the only way we can get data? And what would, you know, I think actually the broker deposit, the broker definition is kind of beautiful.

It’s kind of this, like, you know, how in Bass, we were like debating indirect, indirect for a little bit and the meaning of those words. And I think we all were like, if you’re not, you know, there was almost an attempt to reclassify an indirect arrangement as being less indirect and more direct, but not fully direct, like not a hundred percent direct, but like maybe 80% direct. And it was so, it was so irritating.

And so a broker kind of like saves us from that definition is like, is there just someone in the middle of this deposit from the end customer or not in a way that like the indirect direct, we don’t have to have, but, and that’s fine. That’s fine to say, like some, some deposits come into a bank directly from a customer. Some banks come through someone else, but you still can’t make broad generalizations about that type of deposit, even if it comes through someone else.

And also, you know, you can probably, you probably should understand how different types of brokers and different type of broker deposits will behave differently. But I think one of the issues is the broker, the broker definition is beautiful and simple. The what is a broker deposit and how do they behave is becoming increasingly complex.

And it’s not good to conflate the two of those anymore. Just very, very quickly. I promise.

You know, it’s worth reinforcing that the original law was passed in 1989, which predated broker dealers doing automatic sweeps. It predated widespread use of reciprocal networks. It obviously predated widespread use of the internet and certainly the idea of FinTech or banking as a service.

So it’s like, we have this piece of legislation that is as old as Taylor Swift. And then we have all of these things. I have to get a Taylor reputation.

And then we have, you know, all of these changes in how people access and interact with the banking system, which, you know, I think maybe the legislation was, was slightly amended in like 91, 92. And then you have these waves of like rulemaking that have sort of worked to change the definition, but have not changed the fundamental statute. And, and yes, so I will just go back and say, not fit for purpose.

Let’s go back. Let’s get the data. And then like, let’s start over, but probably not going to happen.

I’m really glad that you mentioned that, Jason. I will take that idea a step further, which is to say, what’s today’s most challenging problem? I promise you, it is not broker deposits. Today’s most challenging problem, C1033, C open banking, is that the same regulators that we’re talking about are promoting, in my view, a very sound policy of consumer choice and account portability.

In my view, the biggest problem that regulators face is this idea of account portability, an idea that they have supported in a parallel proposed regulation, which is supposed to go final next month. It’s the open banking rule. And it’s the idea that individual people should be empowered with data to make choices about where they want to bank, right? That’s the issue.

If you want to talk about SVB and Silvergate and what we’ve learned from that experience, it’s not a broker deposit problem. That’s the reality of today’s apps that allow you to just move your money seamlessly. That is the future.

That is the current state. That is the problem. So I think you’re right to kind of frame what the broker deposit rule was trying to get at.

But then the question is, what should regulators be focusing on most? To me, it’s liquidity. It’s how we think about the stickiness of deposits today and whether our historical assumptions really hold anymore. That’s where I want to see regulators go.

That’s a really interesting point, because I am glad you mentioned that. The thing that I’m always struck by when I look at the original 1989 statute and then sort of how the interpretation has changed around it all is like, what is a deposit broker? Obviously, that’s like the central question that underpins all these rules and discussions is like, how are we defining a deposit broker? Well, in 1989, a deposit broker was a search engine before the internet, right? Like, that’s what a deposit broker was. It was literally like, help me find the highest possible rate.

And it was pretty easy to draw a line between that pre-internet search engine and the behavior of the deposits that it might drive to banks. But yeah, I mean, Alexander, to your point, the thing that’s so interesting now is technology continues to go up and to the right, right? Like everything about how consumers and businesses look for bank partners, choose where they’re going to put their money, and how they keep that money or not, and how they move it around. All of that is dictated by technology as much or more than anything else.

And it is really frustrating. I like the way you described this as just a rollback to before 2020. It’s really frustrating to roll things back rather than to acknowledge, look, technology is not stopping.

And obviously, open banking and the ability for accounts to be more portable. I mean, you hear Director Chopra of the CFPB talk about this, right? He says he wants it to be easier for you to break up with your bank. Well, that should scare the pants off of the FDIC, because what that means is, hey, there you go.

It’s time for OCC hot sauce. I think that you and Acting Comptroller Hsu have a meeting of the minds here. This is exactly his point.

And what I will do is I will go further, and I will open my hot sauce, and I will take your point and say to you that everyone today is their own deposit broker. I love that. 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 I was just at FinTech DevCon last week, plug, great event. And one of the keynotes was Matt Harris from Bain Capital Ventures. And the argument, we’re now bringing in all of my favorite threads, but the argument, part of the argument he was making was around use of AI agents and account portability.

And his argument was that over time, if we can sort of empower, automate, finding me the best rate on my deposits and finding me the lowest rate on my loans or credit products, that is going to compress NIM across the banking sector over time. I do think that the time horizon for how long that will take to manifest is probably more on the 10 years and not on the two years. But that is a fundamental risk or shift in how the bank business model works.

No, that’s right. I mean, I wrote a piece, this is, gosh, maybe like three or four years ago now on self-driving money. And it is like a really popular FinTech VC term that everyone’s been tossing around for a long time.

And the analogy, obviously, is to self-driving cars. And what’s funny is when I wrote that piece four years ago, I sort of pointed out maybe there are limitations to what we can do from a technology perspective with self-driving money. Just look at self-driving cars.

That was right when like the enthusiasm was kind of going out of self-driving cars and people were kind of cooling on the idea. Maybe this is like a technically impossible problem to solve. I just saw that in San Francisco, Waymo is now getting cleared to drive on interstates, right, with no driver in the car.

And so technology does continue to move forward. Jason, to your point, sometimes it’s more of a 10-year horizon than a two-year horizon. Sometimes we get a little too overexcited.

But I don’t really see a world in which, and this kind of goes back to the podcast we recorded more than a year ago, money is just going to get hotter, right? Like money is just going to be hot by default because technology at a sort of atomic level is going to make it hot. And so in a way, and this ties back, Henrik, to what you were talking about with the bank and Raisin as their partner, I think in a way, how we need to think about this in the future is money is hot by default. And the question is, are you delivering a product or an experience, either yourself or through a partner, to a customer that is causing them to choose to irrationally keep their money with you when otherwise you would want to just make it as portable and chasing rates as possible, right? So it’s almost a complete inversion of the old way of thinking about it, which was all money is stable and sleepy and quiet and doesn’t move by default, except for this hot money.

It’s a broker deposit, yeah. Yeah, so like broker deposits was built on this assumption that all money is stable and sleepy by default. This category of money is dangerous and hot, and we need to be careful.

I think in the not-so-distant future, money is going to be hot by default, and the money we’re going to be looking for and probably valuing more is the stuff that actually is a little bit more stable or slow-moving. So you’re saying deposit is a little warming? We’re all waiting for Alex to be done talking. I mean, I get to jump in on this part, right? Because I think the piece you wrote two weeks ago on this, Alex, is you don’t want to acquire customers.

You want customers to acquire you, which is spot on, right? Like that within the Alloy Labs product channel, all the bankers love it, right, on the product discussion, because it’s true. And if you don’t deliver some sort of value, the money is chasing right. I think you were in the room for part of this.

Eric Scherr from Sunrise Bank at our annual member meeting, Kia, and makes the point. And for those who don’t know Eric, he has a very dry delivery. He goes, relationships are the most important thing in community banking, unless real money is on the line, right? So in this new world, where hot money is all money, I think there’s an interesting corollary to how banks, and I would also say fintechs, will react to that.

Aren’t they incented in that new world or in that current world to do the kinds of things to keep those deposits as sticky as possible and to manage their liquidity risk? And isn’t that good, right? And so on. And so if I’m thinking about just the current problem, the biggest problem, how might banks and non-banks do that? I think that’s connected to both Alex’s idea and Jason’s. I’d love to get your thoughts on that.

I mean, one thing that I’ve been thinking a lot about is someone made the point that in a rising rate environment, deposits just become less stable. Deposit betas increase. I actually would really love to read a revisitation of the paper of deposits being the hedge, right? And I do think that we’ve seen banks reach towards term money more just from a liquidity mix perspective.

I think the funding mix is going to have to be more term-based, which might mean more rate-based, which Jason and I think Hendrix worries a lot about NIMS and NIM pressure because obviously the thing you exchange in exchange for the term is the rate itself. And so if you want to have your cheap, sticky, lazy money, the thing that you exchange for the risks that you take now is duration risk. And I also just wanted to throw in that in the 2019 rule, they mentioned software that helps big customers or small businesses move their money around or manage their money.

And that had been classified as brokered. And under a 1033 regime where all the data is extremely portable, and if we have these AI personal finance applications that might serve as a deposit broker, I just kind of love that actually there might be no more core deposits. All the money will be intermediated by a thing that a bank will have to think about the risks of that thing because now it’s labeled brokered.

But obviously, my point is that non-brokered money also carries risks. And we saw that with the uninsured RFI. Does anyone else have any thoughts about competing for money? About self-brokered, right? In a world where we are all our own broker, we need to rethink this.

And you spent a lot of time thinking about deposits. I spent my time thinking about NIMS, that I don’t think enough of the banking sector and the regulators are really looking at what that next 10 years could be. Because whether rates go up or down isn’t going to be the issue.

It’s that portability and liquidity. And the cost of running the bank is only going up. And then there’s pressure on the lending side because there’s more private credit than ever.

And I think as a bank, it isn’t about brokered deposits. You either need to think about how do I change my operating model to drive the cost out of it, right, like lower the floor, or I need to figure out how I change my business model, that I extract more value and I can raise the ceiling. Yeah, I mean, one thought on just like the sort of safety and soundness lens to all of this is, there is and I think Alexander touched on it when she was kind of bringing in open banking.

There is this tension between building a financial services ecosystem that’s better for consumers and building a financial services ecosystem that is profitable for banks to operate in, right. And there is a tension there. And it’s expressed between the different agencies and what their priorities are.

But yeah, I mean, Hendrix, to your point, the more that you push towards, we want the best possible outcomes for consumers and for small businesses. We want them to be able to move money around, get the best rates, right, like even on the lending side, during COVID, when rates went to zero, almost no one refinanced their car loans or their mortgages. And it made tons of sense to do it.

There was just too much work and inertia holding them back from doing that. We can solve that with technology. FinTech can solve that.

And the thing that disturbs me, I think, the most about the proposed rule for essentially rolling back the 2020 change is it does feel like the FDIC and not unfairly because they’re charged with safety and soundness above all else, they seem to take the approach of if some stable, low-risk deposits end up getting classified as brokered and treated in a more punitive way, that is an acceptable cost to pay for capturing 100% of risky, flighty deposits under this brokered classification. And I get why they have that opinion and that viewpoint. That’s like their job.

But it does run smack into the world that I think a lot of other financial regulators are trying to push us towards, which is much more about harnessing the benefits of those FinTech innovations that are maybe going to be harmed by this new rule. Yeah, but I think that I actually do buy, to some extent, Chair Greenberg’s argument that deposits that had come through third-party arrangements have presented risks to banks that maybe the banks had been underweighting. And whether or not I think you should be citing Synapse and Voyager in your RFP or in your proposal in lieu of data is separate from the fact that maybe it’s not clear if those banks in question understood the operational complexity or the legal risk that came from the intermediation of the deposit itself.

I’ve expressed before that I sometimes don’t understand why people put more than $100 into Yotta, but when Jason is on Reddit sharing how devastating it is for Yotta users to not have access to their money because they didn’t understand the risk they were taking with their money because their FinTech partner and that FinTech partner’s FinTech partner didn’t manage the operational complexity of those deposits. What is the FDIC supposed to do other than to say, I don’t think the FDIC is really a consumer-facing agency. Upon review, I don’t think it’s a consumer-facing agency, really.

The word consumer is not in their name and stuff like that. But what are we supposed to do for people for whom not having access to their money is the same thing as not having money at all? This broker deposit rule, if these deposits were labeled brokered, wouldn’t have solved that problem. But it might have, I don’t know, maybe, maybe, might have made them think a little bit about some of the risks of the arrangements themselves that the deposits came through.

So I don’t know if this was the only solution available, but I do kind of take the point that some of these third-party arrangements have happened and maybe it should have had a little bit more thought in them. Yeah, so here’s my response. I think what the FDIC did is take a sledgehammer rather than a scalpel, right? And part of that is, you know, Chair Gruenberg’s days are numbered, right? That’s all public.

He has told everyone he will step down when someone else is appointed. But I think that the broader point here is we actually, as I said earlier, we have a process for the very issue that you just described around the links in the chain, right? See acting Comptroller Michael Su’s speech at the Exchequer Club. Um, that’s the process to, to kind of set the foundation for what might come after either supervisory or guidance or regulatory for how we deal with the very problem and the very obstacles that you just described.

It’s not by taking a sledgehammer to a rule. Yeah, and it does need that scalpel and level of nuance. One of the things I liked about the OCC’s RFI is they finally have acknowledged that fintech and banking as a service are not synonymous.

And they actually went in and, you know, have a sentence defining that, that there are in fact six different models, you know, that they capture around this, that those, that is what the new world needs to account for is the level of nuance that goes into how these operate and each have different sets of risks that need to be controlled for. I do ask the question. I mean, there’s like the scalpel versus sledgehammer.

And then in this specific instance, is this essential reversal of the 2020 rule? Will it actually change anything or make anything less risky? My understanding, and please correct me if I’m wrong, was trying to read everything from 1989 through to the present. This morning was not possible. It’s the error steward, Jason.

That’s what you were doing. That is what I’m doing for deposit regulation. But, you know, my understanding is that basically the classification as broker does two things.

Or there’s two main impacts. Yes, thank you. One is the deposit insurance assessment can be higher.

And then two is you’re not allowed to use those deposits or you need a waiver if you’re less than well capitalized. I was trying to find a quick stat on how many banks are less than well capitalized. The most recent one I could find quickly was in 2019.

And it was like less than 1%. So if you’re asking the question like, OK, what are the mechanics of how this risk manifests? All of the literature and commentary I read basically said using broker deposits to grow very quickly can cause greater losses to the diff if and when that bank were to fail. And then particularly if a bank is less than well capitalized and is trying to grow out of that hole by using broker deposits.

I mean, one of the items I read, and I’m honestly forgetting which policymaker this came from, I think it was in Travis Hill’s statement, was around, hey, if this is the risk we’re trying to control for, does it make more sense to have some sort of growth cap for banks that we are deeming risky, rather than trying to use this sort of roundabout way of saying like, well, you can’t use these kinds of deposits. But I don’t know, maybe go over to this listing service and offer a high rate. Maybe you have an online bank that offers a high rate and you can turn it on and off whenever you need.

Which might have a similar level of risk, but because it’s classified differently, you’re not going to be blocked from doing it. You can actually end up in a position where you’re self-brokering. Different definition than Alex’s in this case, right? So at first, Marblehead, because we were paying private student loans that were 16% to 18% that were being securitized.

So I had no duration risk, right? We could pay top dollar for those, our high yield money market. Except then the FDIC came in and said, whoa, whoa, whoa, you’re paying such a higher rate than other banks. We think those are now risky deposits because you may lower your rate.

I’m like, okay, but that risk is fully within my control. And oh, by the way, like my KPIs and compensation is tied to fast growth. So I am not lowering my rate.

Well, and the other thing too is right now, there are not very many less than well-capitalized banks, but obviously that could change once credit losses begin rising. It’s not always like the best point in time metric. And the other thing too, is obviously if you are less than well-capitalized, you have to have the waiver, but at a certain point, you might have to start rolling off these deposits.

So what happens is essentially a deposit waterfall out of the bank as the broker deposits become due and contractually due. And then you just have to have them leave the bank. And then you get a liquidity crisis, which is not what you want around 4% capital.

The other thing that I just want to touch on real fast, Kia, that you just brought up, which is a great point, is when the deposits roll off because you’ve slipped under that well-capitalized level and either you don’t get a waiver or you become sort of under-capitalized and you have to get rid of these deposits. The challenge is in the old days, that was easy because these were CDs. So the deposits were structured.

They had a term. It was relatively easy. It’s clear to me, like it’d be painful to roll those off, but it’s understood how that would work.

You just don’t get any more of these CDs. I don’t really understand, and maybe Alexandra can comment on this, but I don’t get how a bank that becomes less than well-capitalized easily rolls off BAS deposits, right? And we’re kind of going through a version of this with all the mess that’s happening in banking as a service and some fintech programs looking for new bank partners, like extricating yourself from a BAS relationship, particularly when there’s these end customers that are treating these accounts as operating accounts or core accounts. That’s a lot harder than saying, sorry, we’re not going to renew your CD at this ridiculous rate.

You’re going to have to go find it somewhere else. It is much harder. And case in point, evolve consent order.

There’s a paragraph in that consent order that says, if you, bank, are going to terminate any one of these fintech relationships, you need to come to us, the Fed and also Arkansas, and tell us and show us the liquidity impact analysis. So it’s not just a light switch. You’re absolutely right.

And it’s not something that can be done haphazardly. Or in this case, in the absence of regulatory oversight, for the very reasons that you explained. And that goes back to, again, how sticky are these deposits, right? We come back to the same theme.

Go ahead. It’s not just the liquidity aspect, which is obviously very important. But to Alex’s point, also the operational aspect, if you’re using the evolve example, if you have, you know, 50, 100 fintech programs with debit cards and, you know, people using them to get direct deposit, you know, getting rid of a bunch of brokered CDs when the term comes up, I imagine is operationally relatively straightforward.

And there’s the understanding of how that process works. Trying to get rid of a bunch of fintech programs when customers are using those for their day to day expenses to get their payroll is much more complicated. Well, to that, I was going to say, you know, as we’re thinking about the impact of this role in the industry, especially for the fintech, you know, the banks with extensive deposit fintech partnerships, the two banks that you would want to look at for their experience are Blue Ridge and Metropolitan, correct? Who are have exited fully their BAS programs.

And you can look at maybe how their liquidity has changed over time, how their cost of funds has changed over time. Jason, I think I remember you publishing, looking at the trade between like broker deposits, brokered CDs literally increasing rapidly at this bank as they’re trying to shore up liquidity. And, you know, liquidity facilities are a huge area in the consent orders for the BAS banks, right? That regulators are actually really concerned that they have adequate back, you know, what I would assume is backup liquidity.

But also I would assume that’s actually part of a fintech wind down program, right? To have a backup liquidity. Yeah, sorry. Go on, Jason.

I don’t know. I frantically googled to find my, I remember. Oh, googling to find your work.

That’s very, very sad. Yeah. When Blue Ridge, you know, started off boarding fintech programs, its broker deposits jumped from like two-ish percent to about 20 percent of its deposits.

That’s what FDIC wants to see at banks, right? And its cost of funds jumped from about, well, there’s other factors in that number, but jumped from about 50 bps to like 2.4 percent. I mean, that’s substantial. A quarter of a quarter, that’s crazy.

Well, so. Sorry. Sorry.

And the question on that one, just to put a fine point on it is, you know, under different deposit broker rules, the broker percentage might not change because that’s just like, are we counting these are brokered or not? And, you know, the BAS programs probably would have been considered brokered if there hadn’t been for the 2020 change. But the cost of everything is real, right? Yeah, like that’s like, you know, they weren’t paying the same amount for those deposits when they were getting them through BAS as they would have if they were going out and getting CDs or whatever. So that’s a great point.

And the question becomes back to it all comes down to value in a world where VCs are not the ones funding the value. Do we think enough of the fintech programs themselves are going to provide enough value that those funds are sticky with the fintech, right? Because it’s not sticky at the whoever the endpoint is, the program, to be more precise, it’s certainly not going to be sticky with the bank. Well, I mean, isn’t when the bank make.

So under this, if the rule goes in as proposed, and all of these broker deposits come back at banks and, you know, a number of banks, a significant minority of community banks begin to have brokered concentrations. And it is what it is. So they can either lower the concentration or they can just understand that maybe their fintech deposits count as brokered.

But if they are cheaper than other types of deposits, other like FHLB funding, wouldn’t that be a worthwhile trade-off if you can make these deposits kind of contractually sticky and then do all tack on all the risk management, the capitalization that would allow you to maintain the partnership, right? Isn’t there kind of a trade-off that banks would want to make and it’ll probably come down to deposit costs? Well, I think your hypothesis ignores something that I know you and I have discussed, which is just the stigma. Oh, yeah. We should probably talk about the stigma.

I was going to go there as well. Walking into your bank exam with fresh, new broker deposits, after you’ve made that calculus, Kia, you get the look. Jason, go.

Makula. No, I was going to make the same point. I mean, again, as I was doing my homework earlier today, there were two additional pieces that stood out to me.

One was the stigma piece. It’s one thing to have sort of like a policy top-down reclassification of like, oh, actually, we changed our mind and we’re going to call this a broker deposit again. But I have to imagine, and this is a bit outside my experience, but if you have a bank examiner who’s been at the FDIC for 10 or 15 or 20 years and they’ve built this sort of association that a large proportion of broker deposits equals risk, ask questions, look more carefully, and you’re sort of playing around with the definition of what is and is not a broker deposit, that doesn’t necessarily mean that this is sort of flowing through to how the boots on the ground in West Memphis, Arkansas or Martinsville, Virginia or anywhere else are actually sort of reacting when they see those numbers.

I do think one of the things that’s most interesting about this conversation and the legacy of the broker deposit designation is that the FDIC is kind of indicating where its brain is at, how it thinks about the banking industry. And one of the things that I think is so frustrating is when you’re… I’m very skeptical about VC entrepreneurs and FinTech innovators and disrupting banking, that makes me roll my eyes, but I too can acknowledge that banking is very, very different from 1989. And I think one of the real dangers here isn’t maybe the rule going into effect and then all the tack-on impacts, it’s that I think about banking differently than my regulator does or my examiner does.

And my examiner has this legacy mindset and we just understand the industry differently. And one of the things that I was thinking about, Jason, with your unintended consequences is, does the FDIC even know what risk looks like anymore? Thinking about when we talked last year, we were talking about uninsured deposits, which I think in all the OIG memorandums indicates that regulators thought these were really good deposits and they were indicative of large, significant customer relationships who really liked their bank. You could see on all the camel’s forms that the liquidity was highly rated, like in that category, the L category.

And it seemed like it really caught everyone by surprise that a large deposit can leave very quickly and that will have different impacts than small deposits leaving quickly. And so thinking about that and thinking about interest rate risk and AFS and AOCI, and then tacking on this liquidity understanding is like, can you even see how risk builds in the industry before it is materialized? And if you want to stay in 1989, I can’t force you into the year 2024, but it might mean you can’t see the risks that you’re creating in future years because you’re very focused on what this risk looked like in 1989. Well, and to that point, I mean, Kia, I’ll give you a compliment on air.

So one of the things that I really like about talking to you is a lot of times we’ll talk about stuff where you’re like, just looking at this from a first principles perspective, this thing seems bad, right? Like we had that conversation before SVB blew up where you’re like, I don’t know, this doesn’t look good. It’s funny how risks in the banking system can be sort of understood from a first principles perspective, and they can be understood through a historical lens. And I do think to your point, you know, and you see this at the FDIC, as Alexander said, you know, Chair Grunberg was around for the S&L crisis, like he remembers that he clearly sort of anchors on that as an example.

And I think you see the same thing a lot with kind of the newer generation of regulators who were sort of had formative experiences around the great financial crisis. It’s going to be really bad when we’re all in charge and we’re all GFC alums. Yeah, we’ll just be like, you don’t understand, man, like- Securitization, keep it away.

People will be like, what is your problem? You know, but- Investment grade? No, I don’t think so. Yeah, like just let it go, man, that was a long time ago. Yeah, they’ll be like, just like someone needs to retire this guy.

So I do think in regulation, we have this tendency to anchor on historical examples. But again, as we’ve been talking about, all of this stuff is so subject to technology and the changing consumer behaviors and attitudes. And, you know, 1989, like, I mean, interstate banking wasn’t a thing.

So there’s just all of these changes that happen where the first principles, the basic sort of physics of banking change, and those historical examples become a lot less useful. So I think that’s such a good point about how we need to adapt our thinking moving forward. Well, and playing back on SBB, one of the stories that, you know, teams we had picked up on that’s come out of some of the OIGs, SBB was really a PR failure, right? Like, I will still stand by that, which is when you drop a deck that says, hey, we’re going to take some losses, but it’s okay, we’re going to raise capital after hours in your PR team, like isn’t available to answer questions on Twitter, right? Like that fire just raged out of control.

Yet nowhere on an exam have I seen, you know, an examiner say, hey, like, do you have exposure to, you know, whether it be, you know, large groups of entrepreneurs that are in Slack and WhatsApp channels together, or, right? Like that’s a forward looking risk, not a backwards looking risk. And unfortunately, I think the takeaway we have is large numbers of uninsured deposits equals bad. Wrong lesson.

Well, and we, I mean, I don’t think we have enough time allocated to talk about how things like FedNow and Clearinghouse RTP, again, not today, maybe not tomorrow, but in two years, three years, five years, could take what happened at SBB over the course of a couple of days and make that a couple of hours. Yeah, if I could just quickly wrap up and respond to Kia’s point, we obviously come from different perspectives, right? I think your view is exceptional. And all of you guys, non-lawyers are just like brightening my day.

I would be remiss. As you write your comment letter, as you’re like the only person on this podcast, who’s going to write a comment letter to the FDIC. Don’t tempt me.

We’ll see. We’ll see. I would be remiss if I didn’t say with a completely straight face that this proposal would have significant impacts, not just on FinTech, but also banks and consumers.

And the problem is we can’t really quantify that because we don’t have the data, but we have all the signs. And I would urge folks who are listening to this, regardless of kind of who they are, to comment and to think about the impact of this, not just on themselves, but on their businesses. I think it is a big deal.

It’s why I’m so passionate about talking about it with you all. I think that is a great way to wrap. Alex, thanks for joining us.

Hope you enjoyed your hot sauce as much as we did. I kept blowing my nose while I was muted. I don’t know if you guys saw.

I was like, I promise I’m not being emotional about this. The Chipotle napkins came out with my nose running because I had some ghost pepper stuck. But yeah, I think that’s the great place to wrap, which is the unintended consequences.

Those who are going to lose are likely to be consumers, right? At the benefit of, okay, we’ve stabilized the system, as Alex pointed out, like, great. We’ve captured 100% of this risk, but at what cost? And it’s a backwards-looking, not a forwards-looking approach. Thank you all for joining.

And we have deposits. This time next year, right? Actually, this is going to be the ERA’s tour of deposits. That’s where we’re headed with this one.

And see everyone at Finovate. Yes, everyone at Finovate. Brand new hot sauce is available for listeners.

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

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