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Brokered CDs: What happens if the bank fails?

Certificates of deposit purchased through brokerages are a simple way to buy a variety of CDs from different banks across the country. Often these CDs carry a higher interest rate than is available locally and, since they're FDIC-insured, it's a convenient way of being certain all your CDs are covered within the stipulated limits.

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But what happens if the bank fails? Can you assume that since your CDs are covered you'll quickly receive your deposit and any accrued interest? Bottom line: You'll get your money, but be prepared to wait for it.

When you buy a CD from a bank, you are opening an account with that bank. When you buy a brokered CD, you're simply looking at a list of advertised CDs and selecting by bank, maturity, yield, call protection -- whatever parameters are important to you -- and buying the CD through your brokerage account.

Not having an individual account with the bank doesn't mean you're relegated to second-class status in the eyes of the FDIC if the bank fails. Your deposit is insured and that's all that really matters. But the failed bank's records won't list your name and contact information -- it's your brokerage that's on record.

The FDIC notifies the brokerage that a bank has failed and that there are funds on deposit for which the brokerage is listed as an agent. The brokerage then supplies the requested documentation to the FDIC. As you can see from this tree, it can be a complicated, time-consuming process if the original brokerage parceled CDs out -- not only to individual customers but to other brokerages, who then divided it among more institutions and individual customers.

This is a fictitious example of how a brokered deposit may be divided among many parties. If the bank involved fails, every party must be notified and then submit documentation to the FDIC before insured deposits can be paid to the various parties.

Deposit broker ownership tree
Click on image to see in larger window
Diagram source: FDIC

Brokered CDs have been a boon to banks looking to shore up deposits quickly and easily. Instead of waiting for local customers to buy CDs, a bank enters into a brokered deposit agreement with a brokerage and can rapidly find itself with millions of dollars in deposits. The bank issues large-denomination CDs to the brokerage, which then divvies them up for sale to customers.

Fair-weather customers
But bank regulators are concerned that too many institutions are relying on brokered deposits instead of working to build a strong base of customers who hold accounts with the bank. After all, when a brokered CD matures, the customer generally takes the money elsewhere, perhaps looking for another bank with a higher-yielding CD.

There's no relationship with the bank, no loyalty. The brokered CD customer isn't looking to open a checking account or to take out a loan. The bank can't really count on brokered deposits to stick around very long and help the bank build a strong foundation of organic growth.

Sen. Charles Schumer, a member of the Senate Banking Committee, called it "troubling" that a reported 37 percent of IndyMac Bank's deposits were brokered. The end result of this concern may be that regulators will take a harder look at the amount of money banks hold in brokered deposits.

Still, consumers shouldn't be unduly concerned about buying brokered CDs. Use a bit of caution; be somewhat wary of yields that are substantially higher than the going rate, for instance. Check the institution's relative financial strength in Bankrate's Safe & Sound ratings. It's not a guarantee that a bank isn't on the FDIC's watch list of troubled banks, but it's a good tool. Always stick within the FDIC coverage limits. You may have to wait a bit for the return of your brokered deposit, but at least you know you'll get it.

Bankrate.com's corrections policy
-- Posted: July 16, 2008
 
 
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