U.S. bank funding sources: Do brokered deposits increase the likelihood of bank failures and failure costs?

Banks have long relied on a number of funding sources, including equity capital, non-brokered and brokered deposits, and other liabilities, to make various types of loans and investments. Bank regulatory authorities have imposed various restrictions and costs on those funding sources that are perceived to be excessively risky. We discuss the history and regulation treatment of brokered deposits and the definition of brokered deposits. We rely on the Federal Deposit Insurance Cooperation (FDIC) call report data from 1992 to 2017 to show the wide usage of brokered deposits among U.S. banks. Later we examine reliance on brokered deposits at the individual bank level, specifically brokered deposits-to-total deposits and brokered deposits-to-total assets, and its relationship with efficiency ratio branches. We find that brokered deposits, as an alternative source of funding, actually lower the operating costs for banks. Moreover, we examine whether brokered deposits increase bank failure costs by using the Tobit model and find they do not increase bank failure costs.

Brokered deposits have been incorrectly identified as a cause of bank failure when they have been proven to be a safe and valuable source of funding for banks. We find that 1. Brokered deposits are an important, useful and safe funding source. 2. Brokered deposits have been unfairly linked with bank failures and higher resolution costs. 3. It is the leniency extended to troubled banks, not the type of funding that should be the focus of regulators. 4. The regulations on brokered deposits should be no different from those imposed on other deposits and purchased funds. 5. FDIC should re-examine and re-define the rules of brokered deposit use.

The FDIC should treat brokered deposits as a superior form of bank funding because of their relatively low cost and accessibility. The problem is how funds obtained by troubled banks are used. Banks that acquire any available assets in an attempt to “grow” their way out of their troubles are not demonstrating fund stability. There is likewise no convincing empirical evidence to show that brokered deposits increase the cost to the FDIC when resolving bank failures. The stigma now associated with these deposits, rather than the deposits themselves, may increase resolution costs. Because bank regulatory authorities want to treat these deposits differently, they impose additional costs and scrutiny on the banks that use them, and on the agencies themselves. The problem is with the troubled banks using its funding sources irresponsibly.