US regional banks are rushing to exploit rules that allow depositors to hold tens of millions of dollars in insured accounts, offering security far exceeding government-backed insurance to soothe clients unnerved by the recent banking turmoil.
The move entails the use of reciprocal deposits, which funnel a portion of customer cash to other lenders, keeping the total amount in each account less than the Federal Deposit Insurance Corporation’s $250,000 cap on insurance coverage.
Deposits in so-called reciprocal accounts soared to a new record high of $221bn at the end of the first quarter, up from $158bn at the end of 2022, according to government records compiled by BankRegData. The increase was recorded after the March collapse of Silicon Valley Bank, where more than 90 per cent of deposits were not covered by federal insurance.
Among regional banks advertising high-balance insured accounts is PacWest Bancorp, which like the former SVB often lends to start-ups and their investors.
Beverly Hills, California-based PacWest’s website says clients can “rest assured” because the bank can offer up to $175mn in insurance coverage per depositor, or 700 times the FDIC cap.
Shares of PacWest have plunged by more than a third since mid-March. The bank said in its most recent financial filing that it was enrolling more of its customers in “reciprocal deposit networks”, over which hundreds, or in some cases thousands, of banks spread customers’ funds in order to stretch insurance limits.
The biggest of these networks is run by IntraFi, a little-known Virginia-based technology group. Founded by three top former bank regulators, it is now owned by private equity giants Blackstone and Warburg Pincus and contains about 3,000 banks.
PacWest’s reciprocal deposits rose 60 per cent in the first quarter to $6.7bn and now make up 23 per cent of its overall deposits. The bank recently reported that its percentage of deposits not covered by FDIC insurance had dropped to 25 per cent, down from more than half at the end of 2022.
“Banks are using reciprocal deposits aggressively, as they should,” says Christopher McGratty, an analyst who follows regional banks for Keefe, Bruyette & Woods. He said that in the wake of SVB’s collapse, investors wanted banks to reduce their use of uninsured deposits. “It’s a bit of window dressing, but it’s legit,” he said.
PacWest did not respond to requests for comment, while the FDIC declined to comment. IntraFi said, “Bipartisan laws and regulations have long recognised the value of reciprocal deposits as a stable source of funding that supports local banks and community lending.”
The cap on federal deposit insurance is applied on a per-customer, per-bank basis, meaning that wealthy people can still benefit from protection if they spread their money around multiple financial institutions. Reciprocal deposit networks perform the same function automatically.
Banks can divert large accounts into the networks, where they are parcelled up into $250,000 chunks and sent off to other FDIC-insured banks. The networks match up the parcels so that any bank sending a customer’s deposits into the system immediately receives a similarly sized parcel from another bank.
Crucially, the networks allow banks to increase their level of insured deposits while giving large customers seamless access to their money. Banks pay the network operators a small management fee.
Reciprocal deposits still make up just 2 per cent of the $10.4tn in deposits insured by the FDIC. But they made up a notable 15 per cent of the growth in insured deposits in the first quarter. The share of deposits covered by the federal Deposit Insurance Fund was highest in at least a decade at 56 per cent.
Regulators have largely blessed banks’ use of reciprocal deposits. In late 2018, Congress changed rules to allow banks to consider most reciprocal deposits the same as any other insured account. This status exempts them from the special levy on uninsured deposits the FDIC has proposed to pay for SVB and other recent bank failures.
“Some people have been talking about raising deposit insurance,” said Brian Brooks, a banking lawyer and former board member of the FDIC, who co-authored a recent Wall Street Journal column calling for, among other things, greater use of reciprocal banking networks. “Our point is there’s no need to do something like that because there is already a mechanism for significantly increasing the amount of insured deposits.”
Others have been more sceptical. “To the extent that these deposit exchange programs help weak banks attract deposits, it creates instability,” said Sheila Bair, who headed the FDIC during the global financial crisis. She has called out the deposit exchanges for “gaming the system,” in the past. “It increases moral hazard. There are many good banks that use these exchanges but the exchanges also allow weak banks to attract large uninsured depositors who wouldn’t otherwise bank with them.”
IntraFi is one of the winners of the recent regional banking crisis. Transactions for IntraFi’s main deposit swap business increased in the first three months of the year, according to a person close to the company.
“Turmoil in the banking sector has been a big driver of the demand”, said Tom Ormseth, an executive vice-president at R&T Deposit Solutions, one of IntraFi’s competitors. “It is going to significantly add to our growth over the long-term.”