BY PATRICK HAGGERTY
In the aftermath of recent bank failures and subsequent deposit flight from several regional banks, the way banks classify their deposit liabilities in financial disclosures has suddenly attracted a lot of attention. Filing timely and accurate regulatory reports has long been a cornerstone legal obligation of every bank, but in today’s environment it has assumed even greater significance. In this post we will take a brief look at how we got here and why this issue is important for all banks.
Deposit insurance—or the lack thereof—played a pivotal role in the downfall of both Silicon Valley Bank and Signature Bank and the government interventions that followed. As those banks were failing, and in the weeks afterward, anxious depositors, investors, and regulators have closely scrutinized the level of uninsured deposits at individual banks. Many banks with high levels of uninsured deposits saw their stock prices tumble. Having a high proportion of deposits exceeding FDIC insurance limits is now perceived as a material weakness that can make a bank vulnerable to funding stress.
Following the acute stage of the crisis, and further exacerbating these pressures, in May the FDIC proposed a rule that would require banks with high levels of uninsured balances to pay for the costs incurred by the Deposit Insurance Fund to protect uninsured depositors during the recent bank failures. Large banks such as Bank of America and Wells Fargo have estimated they would each be forced to pay nearly $2 billion if the rule is finalized as proposed. JP Morgan Chase announced that it expects to set aside around $3 billion to cover its share of the costs. However, the special assessments would apply to all banks with at least $5 billion in uninsured deposits, which included 113 banking organizations as of the date the rule was proposed.
These dynamics have caused banks and their regulators to turn their attention to previously overlooked line items in banks’ quarterly financial disclosures, or Call Reports. Insured banks with at least $1 billion in total assets are required to report the estimated amount of their deposits that are not covered by federal deposit insurance. The Call Report instructions acknowledge that the capabilities of a bank’s information systems to provide an estimate of uninsured deposits may vary across account types and among banks, but every firm is expected to use diligent efforts to compile estimates with reasonable precision. The regulators also expect that banks’ reporting capabilities will improve over time.
Perhaps in response to the market and regulatory pressures described above (including the proposed special assessment), some banks have recently revised their estimates of uninsured deposits. By June it was reported, for example, that at least 55 banks amended their fourth quarter 2022 Call Reports to adjust the amount of uninsured deposits, with the majority of those banks making sizable downward adjustments. Some banks have also provided guidance to investors and other stakeholders explaining that certain portions of their deposits labeled “uninsured” may in fact be insured (e.g., on a pass-through basis) or protected in other ways that would make them less prone to a run (e.g., public funds secured by collateral, and deposits from bank affiliates).
On July 21, in a rare instance of bipartisanship, Senators Sherrod Brown and JD Vance sent a letter to the FDIC suggesting that certain types of uninsured deposits indeed should be excluded from the special assessments even if they are technically uninsured. Specifically, the Senators suggested excluding collateralized and affiliate deposits because they are “less likely to run in a crisis,” echoing the position of many regional banks. Importantly though, the Senators did not signal support for banks deviating from their quarterly reporting requirements.
Having taken notice of the trend of banks’ downward revisions to their reported uninsured deposit totals, the FDIC determined that some banks may have acted too aggressively. On July 24, the agency issued a Financial Institution Letter admonishing unnamed banks for failing to adhere to Call Report instructions, and reminding all bankers that filing inaccurate regulatory reports can lead to liability not only for the bank but also for senior executives and directors who are required to attest to the accuracy of the reports. Jumping into the fray, on August 3 two progressive Senators then sent a letter to the FDIC urging it to take even more aggressive action against the offending banks, adding that the situation “is much more than a technical matter” and “the reporting requirements here are not new, nor are they confusing.”
Unsurprisingly, a number of banks that had previously made downward adjustments to their uninsured balances have since amended their regulatory reports again—this time to revise the totals back up.
Regardless of how the FDIC ultimately decides to calibrate its special assessment, a key takeaway from recent events is that filing accurate and precise regulatory reports is critical, and even seemingly esoteric line items can have profound downstream impacts. To name just a few other deposit-related items that come to mind:
FDIC assessments - Even under normal circumstances (setting aside the proposed special assessment), the FDIC’s formula for determining a bank’s insurance cost takes into account the level of its uninsured balances as well as other granular deposit data;
Brokered deposits - Whether a deposit account should be reported as “brokered” under regulatory criteria is hugely consequential for perceived liquidity risk and FDIC deposit insurance costs, to name just two examples, but the rules for making such determinations are complex and not always easy to apply;
Pass-through insurance - Certain accounts may be insured on a “pass-through” basis, which by definition means the bank lacks sufficient information to determine the insured status on its own, thus requiring bankers to make and support assumptions when filing regulatory reports (we have written before about some of the pitfalls related to so-called “FBO” accounts and pass-through insurance);
Liquidity rules - Large banks must apply accurate and consistent classifications to deposit accounts for purposes of complying with enhanced liquidity standards, such as the liquidity coverage ratio and net stable funding ratio (which are due to be revised in coming months, likely heightening the relevance of deposit insurance and brokered deposit classifications); and
Size thresholds for heightened standards - The manner in which a bank’s liabilities are categorized in regulatory reports may trigger other costly obligations, such as requirements to build and maintain enhanced recordkeeping systems under 12 CFR Part 370, systemic risk designations under the G-SIB framework, and the Federal Reserve’s tiering for large bank holding companies.
As pressure on the industry persists and regulators push to make major changes to highly-technical elements of bank regulation, such as capital and liquidity rules, it is crucial that banks and their management teams navigate this terrain with precision and that they understand the downstream implications of even seemingly obscure financial reporting conventions.
Image Source: Mphathi2009, CC BY-SA 4.0, via Wikimedia Commons