Attracting Large Depositors Through Excess Deposit Bonds

Policymakers are bracing for a 2023 slowdown as the global economy continues to work to heal from the pandemic. Rising food and energy prices are likely to cause hardships for many. All of this economic uncertainty is likely weighing heavily on individual investors who want to protect financial deposits, especially before making a large, long-term deposit.

Credit unions must continue to search for ways to grow deposits – especially in these uncertain times. Adopting new strategies to attract large depositors could offer a liquidity buffer for credit unions and increase growth potential during the projected economic slowdown.

Challenges for Credit Unions in Attracting Large Depositors

A credit union’s ability to attract new depositors has historically been limited by membership requirements. Since the 1998 Credit Union Membership Access Act relaxed membership regulations, membership requirements have become far more flexible.

However, challenges in attracting depositors still exist. For one, the public may view membership as a barrier to entry. Also, some smaller credit unions may not offer the same loan and deposit services as banks or the high-tech online or app banking tools that many have come to expect from their financial institution.

Additionally, although there are approximately equal numbers of banks and credit unions in the U.S., credit unions tend to have fewer branches than banks, which could limit visibility and access to ATMs and in-person banking. All of these challenges can limit a credit union’s ability to compete with larger name brand banks, where larger deposits might naturally gravitate.

Public funds are an excellent liquidity source for credit unions to pursue in order to diversify their deposit portfolio. They are considered stable and less prone to market volatility. In some cases, public funds can come with limitations. For example, some statutes governing public funds limit the deposits to local institutions. Others restrict government entities from depositing in credit unions all together. Policies continue to change as credit unions continue to push for less restriction and more competitive parity with their banking competitors. And it makes sense – when statutes allow government entities to deposit in a credit union, it opens up the possibility to save taxpayers money through lower fees, better returns and more opportunity to keep funds local.

A New York Credit Union Association analysis from 2019 concluded that “if credit unions had authority to accept public deposits, each $1 million in deposits in credit unions would produce an additional $3,238 for the locality, when compared to a for-profit bank with the same size deposit.” Another interesting detail from that study stated: “The current restrictions mean that there are teacher credit unions that can’t accept school district funds and fire districts that cannot place money in credit unions that represent said firefighters.”

Growth Through Excess Deposit Bonds

Depending on state or local law, public funds are also required to be secured by collateral or assets of the depository institution. There are many tools available to achieve this requirement. One such tool is the Excess Deposit Bond (EDB). An EDB is a guarantee from an insurance provider that a financial institution will perform its obligation to the depositor. In the event of an institutional default, the EDB can be utilized, and the insurance provider will make the depositor whole in principal and interest. Historically banks have been more inclined to use deposit bonds over credit unions, probably due to more availability and awareness of the product.

Credit unions can increase deposit protection for their clients by working with experts who understand and have developed specialized EDBs. These instruments afford much more flexibility than traditional financial products and allow individuals a safe harbor for large deposits as they wait out market volatility and pursue other investment opportunities. They also release the credit union from indemnity.

EDBs are an efficient option to attract all types of new depositors – not just public funds – that in the past may have not been accessible due to collateral constraints. Most financial institutions limit the number of brokered deposits they take because examiners generally view these deposits as risky.

The EDB program should be viewed as a lower risk option that wealthy individuals or fund managers can utilize to benefit from rising interest rates. It also complies with all state regulations designed to protect funds that exceed FDIC limits. EDBs feature an easy approval process; premiums based on limits used, not on limits available; and, with their competitive rates, are more cost effective than alternative solutions.

For credit unions, an EDB may be an additional way to attract new members and retain valuable members while also meeting their funding needs.

For depositors, in addition to a robust maximum limit, the EDB maintains insured status and the right to file a claim, and offers a certificate of insurance issued in the depositor’s name. The new product is available for all depositor types and accounts, including money market or CD.

When it comes to securitization, EDBs are one of the more efficient methods. Unlike some forms of securitization, EDBs are not affected by market price fluctuations, settlement date limitations and third-party custody requirements. With an EDB, the timeline for application through issuance can be achieved quickly. And, when factoring in operational cost, functionality and regulatory diversification, EDBs can be more cost effective and a competitive alternative for both credit unions and banks.

These are unprecedented times for investors, as the after effects of COVID-19, rising inflation, interest rate risk, cyber risk and geopolitical factors all project volatility in the marketplace. Maintaining a stable core deposit portfolio will be critical to the health of a credit union’s balance sheet. An EDB program, with robust limits available based on a review of an institution’s financial metrics, enables credit unions nationwide to help attract larger deposits, avoid pledging securities and facilitate compliance with state regulations.

Melissa Neis is Vice President of the Chicago-based Parr Insurance Brokerage.