More and more Americans are gaming the deposit-insurance system

Imagine you are the dealer at a vast card table. There are 3,000 players, each of whom is holding a different number of cards. Some have thousands; others a handful. Each will hold onto some cards and return the rest to you. Your job is to reshuffle the deck and deal with it again such that each player has the same number of cards they held before, but none of the same ones they handed over. At any point a player might recall a specific card it once held.

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It is a nightmarish task for a poor human shuffler, but a trivial one for the whizzy algorithms that govern the business of managing “reciprocal deposits”, in which a bank places deposits with another and receives the same value back, via a few mostly unknown technology firms. These quiet giants of financial plumbing reallocate enormous amounts of deposits. Around $1trn-worth are reshuffled through the platforms, of which about a fifth are swapped in reciprocal arrangements. This is a sizeable slice of the $18trn in total deposits parked with American financial institutions at the end of last year.

Deposit-swapping means banks can offer their customers more insurance. After the failure in March of Silicon Valley Bank, where some 93% of deposits were uninsured, this has become a priority for customers and institutions. The cap on insurance—a regulatory guarantee that money will be repaid in the event of a bank failure—is $250,000 per account holder. Wealthy individuals and businesses often hold more than that. Around 45% of deposits in the American banking system were uninsured at the end of last year.

Those seeking more protection would once have had to plod from bank to bank themselves. If an institution wanted to offer greater deposit insurance by placing deposits elsewhere it would have had to forgo using the deposit as funding. But in 2002 the idea for reciprocal deposits was invented by Eugene Ludwig, who previously ran the Office of the Comptroller of the Currency, a regulator. The firm he and his co-founders set up, IntraFi, allows banks to sign up to place deposits around the system such that they are all insured, while also remitting back to the bank the same value of deposits from other places.

IntraFi was the first firm to do this, and remains by far the biggest. It has 3,000 banks on its platform. However, it has been joined by a handful of other companies, including r&t Deposit Solutions, the second largest reshuffler with around 350 banks in its network, and smaller players including ModernFi and StoneCastle Cash Management. These firms are now experiencing something of a boom. Kevin Bannerton of r&t says that the value of his company’s reciprocal deposits has increased by more than 30% since the beginning of March. He reports that new institutions are clamoring to sign up. Mark Jacobsen, boss of IntraFi, says the company has seen “significant” growth in its reciprocal-deposit business over the same period.

All this deposit-swapping raises the question of whether it makes sense to maintain the federal stamp. The private sector has come up with a clever workaround to offer more deposit insurance than mandated. It is conceivable that, with several thousand banks in the network, an account could offer deposit insurance for hundreds of millions of dollars. Indeed, StoneCastle offers an account with $125m in deposit insurance.

But there is a difference between a private-sector workaround and a public-sector mandate. It is currently difficult to match banks so that all are able to offer such high limits (most offer just a few million dollars’ insurance), and reciprocal-deposit firms levy fees, too. They apply on top of the charges, of between 0.05% and 0.32% of the value of total liabilities, that institutions pay for federal-deposit insurance.

Abolishing the cap would make insurance pricier across the system; these higher costs would almost certainly be passed on to customers in the form of lower interest rates. Still, if enough depositors seek insurance by spreading deposits around, higher costs might be the result anyway.

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