The immediate gains, however, will accrue mainly to larger regional lenders. At the end of the first quarter, banks held $69 billion of reciprocal deposits above the old cap. Following the change, $68 billion, or 99%, can be reclassified as lower-risk deposits. Much of that sits at regional banks like Phoenix-based Western Alliance, with $99 billion in assets.
Fed study warns of moral hazard and fund strain
More broadly, a 2024 Federal Reserve study found reciprocal deposits increase moral hazard because depositors have less incentive to monitor risk when they enjoy effectively unlimited government backstops. Increasing insurance coverage while limiting FDIC assessments will also strain the deposit-insurance fund, which holds $155 billion, or just 1.4% of the $11 trillion in deposits it covers. Saving the small-town lender sounds noble, but it might make for a less wonderful life for the nation at large.
The 21st Century Road to Housing Act became federal law on July 11. On top of promoting home construction, the bill includes a number of provisions that will assist the nation's smallest banks, including changes that augment the local lenders' ability to offer deposit insurance well above the Federal Deposit Insurance Corporation's statutory $250,000 per-account limit.
Housing law expands reciprocal deposit treatment
Across the United States, thousands of George Baileys are discovering life can be pretty crummy. Unlike the fictional community banker’s improbable survival, the ranks of small lenders keep shrinking. Federal Deposit Insurance Corporation data show the number of banks with less than $10 billion in assets has fallen from nearly 6,000 in 2015 to 3,852 today. Yet Washington remains determined to keep the neighborhood teller window open. In doing so, lawmakers are edging toward a moral hazard that could ultimately weaken the broader financial system.
Consider a provision tucked into the sprawling housing bill Congress passed in late June. One challenge for smaller banks is that FDIC insurance covers only up to $250,000 per depositor. Customers with larger balances therefore have reason to flee if they sense trouble. The new legislation expands a loophole designed to ease those fears.
How reciprocal deposits receive favorable insurance treatment
Enter the reciprocal deposit. A bank can divide a customer’s balance among multiple peer institutions, securing another $250,000 of insurance protection each time. The FDIC permits the practice and charges lower assessed fees for its insurance on reciprocal deposits, treating them similarly to traditional retail balances, provided they remain below a set share of a bank’s funding. The logic is that depositors with direct relationships are less likely to run than customers whose funds arrive through intermediaries.
Before the housing law, banks could receive the lower assessment on reciprocal deposits up to 20% of total deposits. Above that level, they paid a higher rate comparable to what they would on a deposit received ad hoc through a broker or placement agent. Congress has now lifted the threshold to 50%. Given that community banks hold roughly $2.4 trillion in deposits, the change raises the amount eligible for favorable treatment to about $1.2 trillion from less than $500 billion.
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