New FDIC Rules Apply to Risky Sweep Accounts
Rulings aim to inform commercial depositors of risks in case banks fail.
By David Farkas, Senior Editor -- Chain Leader, 10/7/2008 10:31:00 AM
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| Washington Mutual: one of 16 banks to collapse since February 2007. |
Schildhorn, a workout specialist with Philadelphia-based Eckert Seamans, represents distressed foodservice franchisees. He says restaurant companies that rely on banks for this service--and many do--should carefully review where their deposits are going.
In sweep accounts, banks move funds from depositors' accounts nightly to other financial institutions, often on foreign soil, where the accounts collect interest. In the morning, banks redeposit the money into customers' accounts. In other cases, dubbed "repo" sweeps, funds are used to buy interest-bearing securities. Both types of sweeps are not likely to be FDIC insured because they are no longer considered deposits.
"Let's assume you're a company that has a deposit account in a bank that is also your lender and you have money swept every day into an investment account, say, into Euro dollars or an international bank facility," he says. "Very few treasury departments have asked themselves what's their exposure on these deposits if the bank fails."
Who can blame them? "Until these last few months, whoever figured your bank was going to fail?" he asks. Indeed, from 2005 to 2007 only three banks failed. Since February '07, however, 16 banks have been shuttered, including giant Washington Mutual.
New Ruling
Last July the FDIC issued an interim rule establishing the government insurer's practices for determining deposit and other liability account balances at a failed insured depository institution. The ruling stems from a 2002 lawsuit involving a bank failure in Connecticut in which bank depositors sued the FDIC, arguing their swept accounts were insured and that they were not general unsecured creditors.
Importantly, the new rule requires institutions to prominently disclose to sweep account customers whether the swept funds are deposits (if so, they are insured) and the status of the swept funds if the institution were to fail.
Some depositors, however, direct their funds swept into money market accounts or mutual accounts. Schildhorn believes these are the safest sweeps because the money remains outside the bank until a preset threshold is reached. "Otherwise, your money could be gone [if the bank fails]. A lot of people are just learning about the risks," he adds.
Lack of Knowledge
An FDIC official speaking on the condition of anonymity acknowledges that company treasurers typically do not understand the level of risk they take by using sweep accounts. It behooves them to do so, the official says.
Schildhorn advises treasurers immediately to ask their bankers for the risk status of their sweep accounts--and how they can eliminate high-risk transfers. The FDIC is still seeking comment on the rulings and has deferred the sweep account disclosure requirement until July 1, 2009.
Knowing the level of risk is crucial because things could get ugly fast in an unstable economy. "In the case of a sweep transferring funds outside the failed institution," the new ruling states, "the funds will be treated consistent with how they are reflected in the end-of-day ledger balances, which may mean the funds are not an obligation of the depository institution."
Says Schildhorn: "Unless the money is in something safe like a mutual fund, purchased in the name of the depositor, not the bank, or it's insured, it could be gone."
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