Matt Levine / Money Stuff: Reciprocal Deposits

Old_Joe

In the US, there are basically two kinds of bank deposits. Bank deposits of up to $250,000, per customer, per bank, are insured by the US Federal Deposit Insurance Corp.; they are backed by the full faith and credit of the US government. Deposits above $250,000 are not insured by the FDIC; they are safe if the bank is safe and risky if the bank is risky. Recently many US regional banks have looked risky.

The FDIC does not really price this difference. A bank can’t go to the FDIC and say “I’d like to pay you for insurance on all my deposits up to $1 million”; it doesn’t work that way. In fact the FDIC doesn’t exactly charge banks a premium for the insurance it does provide. Banks pay assessments to the FDIC for deposit insurance, but “the assessment base has always been more than just insured deposits”: It used to be all deposits, and now it is all liabilities. It’s not like a bank pays a premium of 0.1% on deposits up to $250,000 to cover insurance, and 0% on deposits over $250,000 because they are uninsured: It pays 0.1% on everything and only gets insurance on the first $250,000.

And so in rough terms deposits of $250,000 or less come with very valuable insurance for free, and deposits about that amount can’t get that valuable insurance at any price.

And so the easiest most obvious most value-enhancing sort of financial engineering in banking is:

• 1) I am a regional bank and I’ve got a customer with a $450,000 deposit.

• 2) You are a different regional bank and you’ve got a customer with a $450,000 deposit.

• 3) I am worried that my customer will take out $200,000 of her money and move it elsewhere to get FDIC insurance.

• 4) You are worried that your customer will take out $200,000 of his money and move it elsewhere to get FDIC insurance.

• 5) We trade those $200,000 deposits: I put $200,000 of my customer’s money in your bank, and you put $200,000 of your customer’s money in my bank.

• 6) Now both our customers have $450,000 of insured deposits, and neither of us has lost any net deposits: I lost $200,000 from my customer but got $200,000 back from your customer, and vice versa.

This is called “reciprocal deposits” and it’s having a moment. Stephen Gandel reports at the Financial Times:

Beverly Hills, California-based PacWest’s website says clients can “rest assured” because the bank can offer up to $175mn in insurance coverage per depositor, or 700 times the FDIC cap. … The bank said in its most recent financial filing that it was enrolling more of its customers in “reciprocal deposit networks”, over which hundreds, or in some cases thousands, of banks spread customers’ funds in order to stretch insurance limits.

The biggest of these networks is run by IntraFi, a little-known Virginia-based technology group. ...

Banks can divert large accounts into the networks, where they are parcelled up into $250,000 chunks and sent off to other FDIC-insured banks. The networks match up the parcels so that any bank sending a customer’s deposits into the system immediately receives a similarly sized parcel from another bank.

Crucially, the networks allow banks to increase their level of insured deposits while giving large customers seamless access to their money. Banks pay the network operators a small management fee.

Reciprocal deposits still make up just 2 per cent of the $10.4tn in deposits insured by the FDIC. But they made up a notable 15 per cent of the growth in insured deposits in the first quarter. The share of deposits covered by the federal Deposit Insurance Fund was highest in at least a decade at 56 per cent.

Is this good? The argument for it is, look, the government is pricing this insurance irrationally, so rational bankers should load up on it:

“Banks are using reciprocal deposits aggressively, as they should,” says Christopher McGratty, an analyst who follows regional banks for Keefe, Bruyette & Woods. He said that in the wake of SVB’s collapse, investors wanted banks to reduce their use of uninsured deposits. “It’s a bit of window dressing, but it’s legit,” he said.

The argument against it is, look, the government is pricing this insurance irrationally and that leads to misallocations of capital:

Others have been more sceptical. “To the extent that these deposit exchange programs help weak banks attract deposits, it creates instability,” said Sheila Bair, who headed the FDIC during the global financial crisis. She has called out the deposit exchanges for “gaming the system,” in the past. “It increases moral hazard. There are many good banks that use these exchanges but the exchanges also allow weak banks to attract large uninsured depositors who wouldn’t otherwise bank with them.”

The argument against raising the cap on FDIC deposit insurance from $250,000 to infinity is that it creates moral hazard: If you have $20 million to deposit in the bank, we might want you to pay some attention to the creditworthiness of your bank, so that there are some limits on the growth of truly terrible banks. If deposit insurance is synthetically infinite, that has the same problem.