Brokered Deposit - Explained
What is a Brokered Deposit?
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Table of ContentsWhat is a Brokered Deposit?How Does a Brokered Deposit Work?Benefits of Brokered DepositConsiderations
What is a Brokered Deposit?
A deposit broker is anyone in the business in charge of facilitating a third-party fund placement with an insured financial institution. The deposit broker is in charge of placing deposits with insured institutions on behalf of other people. Note that even though financial institutions and their employees, pension plan advisers, and trustees do arrange deposits for individuals and/or banks, they are not considered to be deposit brokers.
How Does a Brokered Deposit Work?
The banks usually sell deposits in larger denominations to brokers, who then divide the huge deposit amount into small and manageable portions. They then resell the smaller denominations to individual investors as well as smaller banks. Note that there are rules that govern brokered deposits. For example, according to Federal Deposit Insurance Corporation (FDIC) rules, banks that are allowed to solicit and accept brokered deposits are those that are well-capitalized. The law allows such financial institutions to accept the brokered deposits after they are granted a waiver. Banks that are allowed to accept this type of deposits are free to access a larger pool of potential investment funds. The banks usually use the funds to improve its liquidity. However, should a bank become undercapitalized, it is banned from accepting, rolling over, or renewing any brokered deposits. The prohibition extends to those banks that deem adequately capitalized. The FDIC rules do not allow them to access the brokered deposits. It is strictly for well-capitalized banks.
Benefits of Brokered Deposit
- Brokered deposits help the banks to boost their liquidity within the banking system. It ensures that a bank has access to enough capitalization it requires to offer loans to the public and businesses.
- Brokered deposits help the banks to save money. To be able to do this, banks usually involve deposit brokers. Broker deposits work well for banks compared to when they handle the same dollar amount involving many smaller deposits.
- Also, individuals prefer participating in brokered deposit transactions because they pay a higher interest rate than that of the traditional deposits.
It is important for corporate and individual customers to investigate the brokered deposit banks origin. It is wrong to assume that this type of deposit is covered by the Federal Deposit Insurance Corporation. Note that the broker is not in a position to offer deposit insurance. So, it is wise to do an evaluation of the bank giving insurance for security purposes. Should the issuing bank fail, you stand a chance of losing unpaid and/or future interest, even if your investment is $250,000 or less and is insured. Observation from Federal examiners sees brokered deposits as a riskier venture for investors. The observation has led to many well-capitalized banks to avoid improving their liquidity using this source of funds. Note that there is no formal rule restricting well-capitalized banks from brokered deposits. However, the reluctance of the examiners to encourage banks to embrace brokered deposits is what discourages banks from engaging in this.