Brokered deposits: addiction to fickle funds ramps up risks for US regionals

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US regional banks have returned to a stable footing after turmoil in the first half of the year. Back then, the collapse of Silicon Valley Bank, Signature Bank and First Republic in the space of just two months set off a crisis of confidence in the sector.

Intervention by the financial authorities forestalled runs on other banks. But profitability remains a challenge. High interest rates mean small and midsized banks will continue to rely on expensive funding — particularly brokered deposits.

As their name implies, these deposits are funnelled in by external partners. For example, a bank will go to a third-party brokerage like Fidelity and ask it to find customers for a large block of high-​yielding certificates of deposit.

For the bank, it is a quick way to get a big influx of funding all at once. For the broker, it is quick way to make some money. 

US banks collectively held almost $1.3tn in brokered deposits at the end of the third quarter, according to the Federal Reserve. That is up from $754bn a year ago and is near the pre-pandemic record high.

The problem with these deposits is their volatility. Investors chasing high returns are apt to withdraw their cash. Federal Deposit Insurance Corp chair Martin Gruenberg has warned that the sharp rise in this “hot money” presents liquidity risks.

Rating agency S&P Global cited these as a reason for downgrading five regional banks earlier this summer.

At PacWest, brokered deposits made up 22 per cent of all deposits at the end of September, up from 11 per cent a year earlier. At Western Alliance, the figure is about 12 per cent of total deposits.

Brokered deposits are expensive. They are driving up costs and weighing on net interest income. The burden is increased by the slowdown in the commercial loan market — the bread and butter of regional banks.

The worry for investors and regulators is that brokered deposits push regional banks into risky lending. The leap from frying pan to fire is dangerously easy.