Impact of the FDIC’s custodial deposit account rulemaking on banks

Reid Thomas, chief strategy officer at treasury services provider Ampersand, recently offered his thoughts on the impact of the FDIC's proposed rule for custodial deposit accounts on community banks with BankBeat. .1. Can you describe the details of the proposed FDIC rule around custodial (i.e. "for the benefit of" or FBO) deposit accounts and what is causing the FDIC to propose these new rules at this time?.In September, the FDIC formally proposed a new rule that would require insured depository institutions to maintain detailed records about the beneficial owners of certain custodial deposit accounts, commonly called FBO accounts. .Specifically, the records will need to include the identity of each beneficial owner, their current balance, and the ownership category (e.g. single, joint, trust, government, etc.) in which the deposited funds are held. The rule proposes that IDIs would also be responsible for reconciliation "no less frequently" than daily. .The recent, high-profile failure of Synapse has brought this to the top of the FDIC's agenda. The FDIC exists to protect depositors in the event of a bank failure and normally relies on the failed bank's records to determine the deposit amounts per category for each depositor. In cases where other service provider or fintech FBO accounts are involved, the FDIC also relies on records kept by the third-party provider to determine the pass-through insurance coverage per category. If these third-party records are not well maintained, it can be impossible for the FDIC to resolve. .Even though there was no bank failure in Synapse's case, it has highlighted this issue and the FDIC's proposed rulemaking is a well-intentioned attempt to preempt such problems in the future. .2. Which types of banks and financial technology companies or services providers will these rules apply to and how will it impact them? .As proposed, all FDIC-insured depository institutions will be subject to these rules to the extent that they hold "custodial deposit accounts with transactional features." .These accounts are defined as meeting the following three criteria:.The account is established for the benefit of beneficial ownersThe account holds commingled deposits of multiple beneficial ownersA beneficial owner can direct or authorize a transfer to a party other than the account holder or beneficial owner..While this proposed rule only applies to IDIs, the fintech companies and service providers that offer these types of accounts would also be affected. To comply, both the bank and service provider will need to work closely together, as the rule proposes that records be reconciled at least daily. .The impact on banks will be significant. It will require substantial investments in new operational processes, management reporting, risk evaluation, compliance and technology systems. .3. How could these rules impact community banks?.Community banks in particular have come to depend on financial technology and third-party service providers to help them grow deposits. These relationships are vital in an environment where core deposits from consumers and small businesses, which have traditionally been the bedrock of community banking, are increasingly difficult to secure directly given advancements in fintech and mobile deposit applications. .The proposed rule imposes stringent recordkeeping, reconciliation, and tracking requirements, which will substantially increase operational costs for banks. Many community and regional banks, already struggling with declining core deposits, will therefore find it difficult — if not impossible — to absorb these additional burdens. .The inevitable result is that many of these banks will be forced to stop offering FBO accounts, reducing options for current and prospective clients and further straining their ability to attract deposits in a highly competitive market. .4. How effective will the proposed rules be at accomplishing the objectives of the FDIC, and what changes would you suggest? .As is often the case, with rulemaking like this, there can be unintended consequences. In this case the community banks are the ones that will suffer most. Numerous smaller community banks are already overburdened with regulation. As a result, many will opt out of offering custodial deposit accounts altogether, effectively reducing access to FDIC-insured deposit solutions for depositors at a time when these services are needed. The unintended consequence of this rule will be a further concentration of deposits into larger financial institutions, to the detriment of smaller banks and their institutional clients. .Perhaps the FDIC could look to other examples within financial services or completely different industries to explore ways to help banks, as core service providers, to ensure their third-party partners meet a defined standard of operational controls and technical interoperability. For example, banks working with custodial account applications delivered by third-party firms, which operate within stringent regulatory frameworks overseen by the MSRB and SEC, could be exempt or at least have a lesser burden. These firms already adhere to rigorous standards that provide the protections the FDIC seeks to enforce.