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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. or for than do know, more of 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 Moreover, 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 innovation — Nationwide 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 Board financial however, social benefits believes 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 may Methods by which include 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. # # # # # # # # to
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