The Federal Deposit Insurance Corp., or FDIC, is changing the way it determines the maximum interest rate that troubled banks may pay for deposits such as certificates of deposit, money market accounts and savings accounts. The institutions that fall into this category are classified as less than well-capitalized and, fortunately for consumers, there are relatively few. Well-capitalized banks can set deposit rates as they wish but rarely pay above the prevailing rates.

Banks that are less than well-capitalized include those that the FDIC classifies as adequately capitalized and undercapitalized. It appears that fewer than 250 of the more than 8,200 FDIC-insured institutions are not well-capitalized and, therefore, are subject to the FDIC’s interest rate restriction regulations. But considering the current banking landscape, that number could grow significantly.

FDIC’s national rate

Under the new rule, which takes effect Jan. 1, 2010, the FDIC will establish a national rate by using a “simple average of rates paid by all insured depository institutions and branches for which data are available.” If the agency determines that the national rate is too low in a particular market, the affected banks will be able to pay up to 75 basis points above the prevailing rate in that market.

Brokered deposits — CDs purchased through brokers, such as Fidelity Investments or Charles Schwab — are also subject to rate restrictions. Undercapitalized banks are not allowed to accept brokered deposits, but adequately capitalized banks may if they have permission from the FDIC.

“Sometimes a troubled institution can jack up its interest rates to keep money coming in with the thought that they’ll hit that home run and grow themselves out of their problems,” says FDIC spokesman David Barr. “But what they tend to do is dig a deeper hole for the government to fix. So ever since the savings and loan crisis, there’s been (an effort) to limit the loss to the Deposit Insurance Fund from bank failures.”

Previously, the FDIC tied the interest rate cap to Treasury rates. That proved less than ideal in a continued low-rate environment, and in addition, critics say the rules were vague and compliance was difficult.

Michael Shumaker, an attorney with Bryan Cave in Atlanta who specializes in financial institutions and regulatory compliance, says now there’s much more of a bright-line rule.

“The FDIC has declared that if you’re in compliance with the national rate caps, the bank will be in a ‘safe harbor.’ But I think a lot of banks will still have some trepidation. A lot of banks are new to experiencing this rule at all because they’re just now coming under enforcement actions.

“The advice we’ve been providing to clients is to immediately check the (FDIC’s) national rates, then they’ll know if they have a problem. They could be looking at The Wall Street Journal every week and saying, ‘We look good, or we checked Bankrate and we’re way below those (rates).’ For all we know, the FDIC may be very lenient in terms of allowing different local market rates. But it seems like they really prefer that banks comply with the national rates,” says Shumaker.

Brokered deposits a problem?

Over-reliance on brokered deposits has become a common thread in many of the recent bank failures, according to the FDIC. While consumers enjoy easy access to CD yields that may not be available at their local banks, the institutions that are paying those higher rates may be doing so because they’re desperate for cash.

BancVue, the Austin, Texas, company that makes another high-yield product that’s popular with consumers, says its checking accounts aren’t contributing to bank failures.

REWARDChecking, typically available at community banks, is a no-fee checking account that currently pays about 3 percent to 4.5 percent to customers who can abide by requirements such as using a debit card a certain number of times each month, having a check directly deposited to the account and receiving statements electronically.

BancVue CEO Gabriel Krajicek says comparing REWARDChecking to brokered deposits is like night and day.

“Our accounts generally don’t make up more than about 10 percent to 15 percent of the total deposit base. Brokered deposits can represent a big chunk of a bank and they can really get stuck living hand-to-mouth with that hot money. Our accounts represent a real customer relationship that’s generating a lot of noninterest income as well as cross-sale opportunities, which also can generate fee revenue,” he says.

For consumers there is little danger in buying FDIC-insured brokered CDs through well-known financial institutions. FDIC-insured high-yield checking accounts also present little, if any, risk. The one caveat is to always stay within the insured limits.

An easy way to gauge the financial health of your bank is to use Bankrate’s Safe & Sound feature. Keep in mind that we are in an economic climate where an institution’s financial health can appear to head south very quickly — a bank that looks OK one quarter may slip to a subpar rating the next. Staying within the insured limits is the only way to truly protect your deposits.

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