CD network helps community banks build core funding

Northwestern Financial Review, Feb 15-Feb 28, 2003 by Bengtson, Tom

Eugene Ludwig, the former comptroller of the currency, is developing a new network for community banks to trade certificates of deposit so they can offer customers deposit insurance protection in excess of $100,000.

Ludwig's Promontory Interfinancial Network already has more than 100 banks signed up for its Certificate of Deposit Account Registry Service. Banks that subscribe to the CDARS split up deposits in excess of $100,000 between their own bank and other participating banks. Since no individual bank holds more than $100,000 of a single depositor's money, the depositor's entire amount is protected by the FDIC.

When a customer comes into the bank with a large deposit - say $500,000 - the bank keeps $00,000 and it sells four individual $100,000 CDs to four other banks. The.original bank then gets $400,000'in CDs from other banks in the network that are placing money for their large depositors. Since a bank gets CDs from other banks, the network gives a bank the full benefit of the entire deposit, even though it is split up among several banks. A fee is exchanged to compensate for the difference in rates between the various CDs.

The CD exchange is administered by CDARS in a seamless fashion for the customer, who only has to deal with a single bank. The customer, however, does get a statement that explains how the deposit has been divided and what banks are holding what amounts.

"If large banks and non-banks could broker deposits, why couldn't community banks?" asked Ludwig. "We asked, what if community banks worked together to sell each other certificates of deposit? The net effect should be an increase in core funding for community banks."

Ludwig said that when he was comptroller of the currency in the 1990s, bankers frequently told him funding was a growing concern. Although deposits in many parts of the country have since increased, Ludwig said banks still have funding concerns.

First Citizens National Bank of Mason City, Iowa was one of the first banks to sign up, and the bank's chairman O. Jay Tomson is one of many well-connected people serving on the Promontory Interfinancial Network board of directors. Others include former FDIC Chairman L. William Seidman, former U.S. Senator Warren Rudman, former ABA President James Culberson, former Federal Reserve Board Vice Chairman Alan Blinder and former FDIC Chief of Staff Mark Jacobsen.

"The CD registry service allows small banks to offer a brokerage service that large banks have been offering for years," noted Tomson.

Tomson said the product may make it easier for some banks to attract municipal deposits. Laws vary but in many states, banks are required to pledge assets against uninsured deposits. CDARS would give a bank the ability to insure the entire amount, no matter how large the deposit.

In Iowa, however, beginning July 1, banks will be required to pledge dollar-for-dollar on municipal deposits that exceed the bank's amount of capital. That applies to all deposits, whether they are insured or not. John Sorensen, president of the Iowa Bankers Association, said if bankers ask the association to seek a change in the law as a result of their participation in CDARS, IBA would lobby for a change. He said he expects the initiative would not be controversial with legislators.

Ludwig was scheduled to be in Iowa to participate in the IBAs management conference earlier this month.

Ludwig said he does not expect CDARS to have an affect on public policy discussions regarding deposit insurance reform. "I have spoken to each of the regulatory agencies and I have heard no objection of any kind," Ludwig said.

The product is being developed primarily to help community banks build their core deposits, Ludwig said. Those likely to benefit most from the product, he said, are middle-class invectors, charities, municipalities, schools and other entities that have more than $100,000 and "can't afford to lose it."

"What I'm interested in is keeping my depositor's money," commented Tomson. "Too often, they want to split it up and CDARS gives me the opportunity to tell the depositor that he or she no longer needs to split it up."

By Tom Bengtson