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For release on delivery
3:00 PM, EST
March 14, 1984

Statement by

Lyle E. Gramley

Member,

Board of Governors of the Federal Reserve System

before the

Subcommittee on Commerce,




Consumer and Mone ta ry Affairs

of the

Government Operations Committee

United States House of Representatives

M arch 14, 1984

Mr.
to have

the opportunity to present

Governors
the

use

Board's

Chairman and members of the Committee,

of the Federal
of

fully

position

function.
however,

institutions,
deposit
to

is

to

the

use

the

on

risks

The

such

proposal

published

for

Board

Insurance

(FSLIC)

serve

Federal

legislation
the

not object

Federal

and the Federal

the

useful

Until

the Board would

to limit

to limit

deposits,

the

that

needed.

the

of

depository

to

believes

by

a

brokered

and

is

comment

(FDIC)

Board

Briefly,

individual

deposits

Insurance Corporation
Corporation

insured

system,

necessary legislation is passed,
the

deposits

to

financial

funds.
of

deposits.

brokered

reliance

the

System on proposals

brokered

that

serious

insurance

limit

insured

Excessive
poses

Reserve

the views of

I am happy

Savings

insurance

to

Deposit
and

Loan

coverage

to

$100,000 per brokerage firm.

Insured brokered deposits
of

funds

to

the

nation's

are a relatively new source

depository

institutions.

data on how large the activity presently
growing,

are

sparse.

deposits

at

federally

(S&L's)

rose

from less

We

know,

insured
that

is, and how

however,
savings

that

and

$2 billion at

total

loan

Reliable
fast

brokered

associations

the end of

1979

something like $25 to $30 billion at the end of last year.
commercial banks,

to
At

brokered deposits at the end of 1983 amounted

to about $22 billion.




it is

- 2 -

It

appears

heavily on brokered
surprisingly,
deposits
the

deposits

smaller

deposit.

for

know,

more

of

Moreover,

than

do

also,
their

among those

that

S&L's

commercial

rely more

rely more

banks.

heavily

Not

on

such

institutions that have ready access

large-denomination

We

or

data

institutions

than do larger

market

half

from available

that

a

total

negotiable

few

individual

deposits

institutions

certificates

through

S&L's

to
of

obtain

brokers.

relying heavily on brokered

deposits are a number with relatively low ratios of net worth
to

total

liabilities —

percent.

Such deposits

that

is,

ratios

of

less

than

three

constituted approximately one-sixth of

total deposits held by banks that failed in the past two years
and,

in

a

few

of

cases,

and,

failing

more

than

that there is a tendency for the marketing process

institutions —

the

to

suggests

deposits

of

amounted

of

brokered

deposits

they

one-half

direct

total

those

toward

institution.

financially

in extreme cases,

to failing institutions.

very small in relation to total deposits.
is rising rapidly,

The

factors

growth

rise

to the

recent

Apparently,

however,

effects of some of
of

such as regulatory actions permitting payment




is still

and no one can be sure what

the limits of this market may be.
giving

to

weaker

The volume of fully insured brokered deposits

the proportion

This

the
of

the

industry —
finders'

fees

-3-

to brokers

and

Institutions

the

Deregulation

ceilings on most
growth

in

effective

the

deregulation

Committee

future.

however,

financial

Nationwide

innovation —

stems

more

advances -- that

dramatically,

and

the

impact

institutions

is

element of subsidy contained
provide

of

Depository

interest

a continuing

marketing

generally

of

rate

from

a

is changing
of

those

far

from

process

forces
over.

to growth

and

of
rapid

financial practices
on

financial

Moreover,

in Federal deposit

incentive

to

brokered

driven by both deregulation

technological

and

(DIDC)

the

time deposits -- may be less of a catalyst

deposits,

markets

by

of

the

insurance will

insured

deposits

channeled through brokerage arrangements.

Brokered deposits would be less of a problem
standpoint

of public policy

Uncertainties prevailing

if they were

not

fully

in financial markets

from the
insured.

in recent years,

however, have caused depositors to place a high value on safety
of principal.
Square

For example,

National

incurred

Bank

losses,

the failure and liquidation of Penn

in July

served

as

1982,
ah

in which

important

many

catalyst

practice of breaking up large brokered deposits
$100,000

or

insurance,
to seek

less

to achieve

in such cases,

strong,

to place their

insured

the

the

into amounts of

status.

incentive

depository

to

Federal

for depositors

institutions

This lack of market discipline

unfortunate consequences.



removes

well-managed
funds.

fully

depositors

in which
can have

-4-

Brokered
economic benefits
the nation

as

deposits,

a whole —

transferring

areas.

Board

believes,

to individual depository
benefits

They serve as a conduit —
for

the

funds

They permit

from

should

with

capital-rich

depository

on more

equal

funds.

They provide an additional

individual depositary

institutions
be

and

to

preserved.

although by no means the only one

smaller

grounds

that

provide

larger

institutions

to

capital-short

institutions

ones

to compete

in the attraction

source of

of

liquidity to the

in time of need.

And

they

increase the options open to depositors -- institutions as well
as individuals —

in the placement of funds,

and often

increase

I know

that

the yields available to them.

There

are

no empirical

studies

that

of

seek to put quantitative dimensions on such benefits.
must

recognize

well

as benefits,

For

example,

that

brokered

deposits

particularly

facilitating

easy

market to another through full
loosens
local

the

links

institutions.

depository

between

they

movement
insurance

depositors

and

rise

are
of

improves,

may deteriorate,

local needs for credit.

but

reducing

to

costs

fully
funds

from

consumers

that
their

of
of

we
as

insured.

for brokered

The competitive position

institutions

institutions

when

give

But

deposits

and

some
other

ability

one

their
smaller
small

to

meet

Heavy reliance on brokered deposits as

a source of funds may encourage some institutions to move away




-5-

frorr. their traditional community orientation,
are

hard

to

predict

on

Indeed,

it

communities.

the

is not

efficiency is increased when
to another

in

welfare

entirely

of

clear

funds are transferred

of subsidy contained

fact,

lead

to

in Federal

the opposite

result

that

those

that

solely because brokered deposits are

The element
may,

economic

with effects

economic

from one use

fully

deposit
because

insured.

insurance
it

erodes

market discipline as regards risk taking.

While
deposits

are

continued

the

economic

mixed,

use of

the

this

Board also believes,
insured brokered

and

financial

however,

benefits

believes

Board

social

that,

instrument

that

funds results

of
on

brokered
balance,

is desirable.

excessive reliance

in risks

that

are

on

The
fully

sufficiently

serious to warrant prudential measures by the Congress and

the

Federal regulatory authorities.

First,
financial

there

are

institutions

employing brokered

a spectacular pace,

depositors
funds




an

that

not

be

the

individual

capable

as sometimes happens.

and a fee

for

of

often

pays

to the broker.
institution

to grow at

To attract brokered

above-market
In order

must

safely

especially when the

funds permits an institution

institution

profitably,

may

created

funds on a large scale,

attraction of brokered

deposits,

risks

invest

rates

to employ
them

to
the

in assets

-6-

that earn a relatively high
such

higher

rates

of

rate of return.

return

are

earned

Methods
include

may

by which
taking

greater than normal credit risks and mismatching of maturities.

Over time,
on brokered

an institution may become overly dependent

deposits

as a source of

to diversify sources of deposits,

funding.

this dependency may make the

institution susceptible to pressures
source,

including suggestions that

particular borrowers.
particularly
scale

that

control

likely

its

credit

from the principal

its

an

institution

capacity

decisions.

funding

it make credit available

Failure to make good credit
when

exceeds

Despite efforts

to

obtains

document

Experience

judgments
funds

properly

has

to

on

is

a

and

indicated

that

this can prove to be troublesome.

Brokered
individual

deposits,

depository

it

is

sometimes

institutions

with

restructure their assets and liabilities
better match of maturities.
it

is also true that

That

the

provide

opportunity

to

in ways that lead to a

is true.

the opportunity

argued,

But unfortunately,

is provided

to create

a

serious mismatch by borrowing short and lending long.

When

an activity

rapidly as it has
problems




of

such

as brokered

in recent years,

individual

financial

there

deposits

is a danger

institutions

may

grows

as

that

the

become

so

-7-

widespread as to warrant concern
markets more generally.
moment,

but

the

depository

That

prospect

institutions

for the stability of financial

is probably not a concern at the

that

might

even

larger

become

numbers

heavily

of

small

dependent

on

relatively higher cost,

and potentially highly volatile,

of

their

deposits

to

finance

lending

activities

is

a

source

clearly

worrisome.

Troubled institutions may end up with relatively large
volumes

of

insured

brokered

deposits

institution is facing difficulties,
sources of

funds

it can still

be used to replace uninsured
wary depositors,

because

once

this may be one of the

attract.

and

result

the

end

institution,

is

increase

to

growth

prolong

the

life

size and

of

a

in the

in existing

all too often the effort

its overall

volume of insured deposits,

can

funds that are being withdrawn by

hope that the earnings generated will offset losses
Unfortunately,

few

Brokered deposits

or to finance additional asset

operations.

an

is futile,
failing

in particular

and add to the liabilities

the

faced by

the Federal insurance funds.

The danger
a

clear

Federal

and

present

insurance

to the Federal deposit
one.

funds

The

potential

insurance
liability

system
to

is

the

is growing at a disturbing rate as the

reliance on fully insured brokered funds increases, particularly




-

when

such

deposits

are

8

-

concentrated

among

financially

weak

institutions.

The proposal
FSLIC,

published

limiting Federal

for

comment

by

the

FDIC

and

insurance to $100,000 per broker,

severely limit the use of brokered deposits.

would

A l^:;s disruptive

means of addressing this problem would be to impose a limit on
the

total

amount

J

insured

accepted by a depository

brokered

deposits

institution.

This

that

may

limitation

be
could

take the form oi a "cap," calculated as a percentage of insured
brokered

deposits

to

total

deposits,

Alternatively, the proportion
could be made

to depend,

of

of,

such

be

clearly

set,

authorities

it

to have

would
the

be

on

desirable

for

to

to

the

Although

flexibility

five

deposits

to some degree,

institution's capital to its assets.

say,

the

total

ratio of an

the limit should

the

grant

percent.

regulatory

exceptions

in

special situations.

Effective
brokered deposits
with

new

authority,

implementation

legislation.

The

regulatory

through cease and desist

requires

a

on a system-wide basis

institution-by-institution
authority

of

proving

basis.
for

"cap"

on

could

best

agencies

powers,
However,

each

do

insured
be

done

have

the

to proceed
using

situation

a

this
direct

relationship between safety and soundness and a specific




on an

level

-9-

of

fully insured brokered

deposits,

a process

that

could

bog

down in litigation and delay.

The Congress
capital

adequacy,

and

authority to require
with

the recent

the case of

faced a similar problem
it

provided

specific

regulators

levels of capital

IMF legislation.

fully

the

in the

deposits.

with

new

in connection

Similar action

insured brokered

field of

is needed

Because

of

in
the

inevitable pressures that would be brought to bear on agencies
to

broaden

established

and

make

levels

more

flexible

pursuant

provided by Congress,

to

any

a general

we believe that

administratively
grant

of

authority

in this instance it would

be desirable for Congress to set a specific legislative cap.

Legislative

caps

have

the

advantage

reasonable use of insured brokered deposits,
such

use

within

limits

manage.

In view of

brokered

funds

prepared

to

rates,

the

access

and

correct,

to

take

the

institutions

inherent

gravitate

to

the greatest

risks

thus

with

avoiding

cease

the

and desist

while maintaining
be

for

fully

incentive
those

allowing

should

institutions
and

to pay

"cap" approach takes the prudent

after it has occurred.




that

of

necessity
action,

of

able

insured

that

the

are

highest

course of

limiting

attempting

a dangerous

to

to

situation

- 1 0-

In the design of enabling legislation,
given

as

to how

disruptive

such

effects

a

on

cap

should

individual

fully insured brokered deposits

be

phased

in

institutions
to the total

thought must be
to

whose
exceeds

avoid
ratio

of

the cap.

(The Board does not believe that grandfathering existing ratios
would

be

appropriate.)

discourage

increases

It

would

be

desirable

to

in reliance on such deposits prior

effective date of the cap.
with the Congress

also

The Board would be happy

to the

to work

in developing legislative language that would

achieve such results.

The Board recognizes

that

Congressional

may take some time to enact and implement.
to take action now to prevent problems
the Board would not

object

to

made by the FDIC and FSLIC
pending

the enactment of

of a legislated
included

cap,

arrangements

brokered deposits

an

for those

As

desirable

orderly

of

later,

the proposal

rule-making process
with

implementation

if their proposal

phase-down

of

insured

institutions already significantly

dependent on this source of funding.




from developing

in its current

it would be
for

In view of the need

implementation

legislation.

authorization

-1 1 -

If the Congress

is disposed

to enact

new

imposing a cap on fully insured brokered deposits,
desirable
take

for such legislation

effect

proposal

prior

is scheduled

dependent on such
activity,




to

1984,

to take effect.
and

it would be

to be enacted promptly

October 1,

funds,

legislation

brokerage

when

the

Depository
firms

and

FDIC/FSLIC
institutions

engaged

in this

would then be disrupted less by regulatory change.

# # # # # # # #

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