The Federal Deposit Insurance Corporation (FDIC) proposed a new rule yesterday aimed at strengthening recordkeeping requirements for custodial deposit accounts with transactional features. This proposal comes in response to evolving banking practices in the digital age and recent events that have highlighted potential risks to consumers and the deposit insurance system.
Background and Rationale
The proposed rule addresses the changing landscape of deposit-taking, particularly the "widespread use of digital channels, including websites and mobile applications, which created new opportunities and options to deliver financial products and services to consumers." However, these innovations have also introduced new risks, including potential confusion about deposit insurance coverage and accessibility of funds.
A key driver for this regulation was the bankruptcy of Synapse Financial Technologies, Inc. in April 2024. This event "affected the ability of consumers to access funds placed at IDIs for a number of months, resulting in significant and ongoing harm to those consumers." The Synapse case exposed vulnerabilities in custodial deposit account arrangements, particularly when involving third-party fintech companies.
CFPB Director/ FDIC Board Member Rohit Chopra highlighted the severity of the situation:
"This year, Synapse, a middleman between nonbanks offering deposit-style products to end users and their partner banks, filed for bankruptcy. The firm appears to have failed to properly track customer account balances and may have engaged in other shady practices. As a result, tens of thousands of customers have had their funds frozen for months. The banks have been unable to reconcile all the records necessary to get end users their funds back. This has led to severe harm, especially for people who were using the nonbank account as a primary checking or savings account."
The FDIC notes that "if an IDI has an arrangement with a third party where custodial deposit account recordkeeping is inadequate or unreliable, this would impede the FDIC's ability to promptly make deposit insurance determinations in the event of its failure."
Key Provisions of the Proposed Rule
The new regulation would apply to "custodial deposit accounts with transactional features," defined as accounts that:
1. Are established for the benefit of beneficial owners
2. Hold commingled deposits of multiple beneficial owners
3. Allow beneficial owners to authorize or direct transfers to parties other than the account holder or beneficial owner
The rule would require insured depository institutions (IDIs) to:
1. Maintain detailed records of beneficial owners, their account balances, and ownership categories
2. Use a specific electronic file format for these records
3. Implement robust internal controls and daily reconciliation processes
4. Establish clear contractual arrangements if using third parties for recordkeeping
Impact on Financial Institutions and Banking as a Service
This proposal will significantly affect IDIs that offer custodial deposit accounts, particularly those working with fintech partners in Banking as a Service (BaaS) arrangements. Key impacts include:
1. Enhanced Recordkeeping: IDIs will need to invest in systems and processes to maintain more detailed and standardized records of beneficial owners.
2. Third-Party Management: The rule places strong emphasis on IDIs' responsibility for third-party recordkeeping, requiring "direct, continuous, and unrestricted access to records maintained by the third party."
3. Operational Changes: Daily reconciliations and new internal controls will require operational adjustments for many institutions.
4. Compliance Burden: IDIs will need to establish new policies and procedures, conduct annual testing, and provide certifications and reports to regulators.
5. Potential Market Shifts: The increased regulatory burden may impact the economics of some BaaS arrangements, potentially leading to market consolidation or shifts in business models.
Conclusion
This proposed rule appears to be a necessary step to ensure the stability of the deposit insurance system and protect consumers in an evolving financial landscape. By enhancing recordkeeping requirements and clarifying responsibilities in complex custodial arrangements, we aim to "promote the FDIC's ability to promptly make deposit insurance determinations and, if necessary, pay deposit insurance claims 'as soon as possible' in the event of the failure of an IDI."
Credit unions should expect NCUA to follow suit with a similar rule soon. I doubt it can be as soon as tomorrow. NCUA's meeting tomorrow has this item on the agenda: Final Rule, Part 745, Simplification of Insurance Rules. I doubt they had the legal authority to sneak this in unless they opted for emergency authorities.
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