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FDIC Rethinks Hot Money, Again
In 1982, the U.S. House hauled the leaders of Penn Square Bank before the banking committee, along with regulators. The Oklahoma City bank had recently failed due to risky and fraudulent energy loans, and it almost took the financial system down with it.
“Penn Square was clearly the granddaddy of bank failures,” Phillip Zweig wrote in his 1985 book, “Belly Up: The Collapse of the Penn Square Bank." Based on size, it ranked fourth among U.S. commercial bank failures at the time. Prominent banks bought Penn Square’s poorly underwritten loans, and the loan participations contributed to the 1984 insolvency of Chicago-based Continental Illinois, costing the Federal Deposit Insurance Corp. $1.1 billion. Some 174 financial institutions, most of them credit unions, had more than $100 million in brokered deposits in Penn Square.
The FDIC recently used Penn Square as an example of the dangers of so-called hot money in proposing new rules that would revisit how the agency defines brokered deposits. “Brokered deposits contributed to Penn Square Bank’s rapid deposit growth, which were used to fund high risk loans,” wrote the FDIC in its notice of proposed rulemaking.
In redefining hot money, the FDIC would roll back a 2020 rule that created carve-outs from the brokered deposit rules for various deposit arrangements between banks and nonbank companies. The changes impact affiliated sweep deposits as well, which played a role in First Republic Bank’s 2023 failure, per the FDIC.
What is or isn’t a brokered deposit matters, especially to banks that aren’t well capitalized. Those institutions can’t accept brokered deposits, according to Section 29 of 1950’s Federal Deposit Insurance Act. Further, institutions that are adequately capitalized need a waiver from the FDIC to accept those deposits. Banks will have 60 days to comment on the proposed rule.
The recent bankruptcy of Synapse Financial Technologies, a middleware platform that connects banks and fintechs, left some neobank customers without access to their funds, showing that deposit arrangements with nonbanks do carry risk. But those deposits aren’t what most would think of as hot money. The relationships tend to be relatively exclusive, and depositors generally aren’t seeking a better rate.
However the FDIC ultimately defines brokered deposits, bank boards should understand the broader risks and unique characteristics of their deposit base. Penn Square’s board members didn’t grasp those risks. In his testimony before Congress, Penn Square Director Bill Stubbs was asked if the board understood how brokered deposits functioned. His answer: “No.”
• Emily McCormick, vice president of editorial & research for Bank Director
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