Using Standby Letters of Credit to Collateralize Your Public Deposits
by John P. Biestman
Federal Home Loan Bank of Seattle
From a financial institution’s perspective, public deposits can represent a key part of a diversified funding portfolio. Cities, school districts, and other municipal authorities typically establish public deposit accounts in the form of either demand (transactional) accounts or time deposits. Frequently, public entities hold deposits within pools of funds that are managed under the auspices of a State Treasurer or governing board. Funding pools for public entities allow these depositors to take advantage of economies of scale to gain competitive rates of return on their deposits. As prudent fund managers, public depositors are focused on the issues of safety and soundness, concomitant with the benefits associated with earning an acceptable rate of return on their excess funds. Security in a public deposit is paramount to a public depositor.
Under “permanent” rules, the FDIC and NCUA insure interest bearing, non-transaction separate accounts in insured depository institutions for balances up to $250,000. Treatment is similar for demand deposits owned by a public entity, also under permanent rules (FDIC, Deposit Insurance for Accounts Held by Government Depositors). However, the Dodd-Frank Wall Street Reform and Consumer Protection Act specified that transaction accounts will be accorded unlimited insurance coverage through December 31, 2012. Beginning January 1, 2013, these accounts will have to rely on insurance policies covered under permanent rules. Translated: Unless unlimited transaction account insurance is restored by legislation, public deposits in transaction accounts will no longer be protected against financial institution default in excess of $250,000. In the event insurance must be provided under the permanent rules, many public depositors will be forced to seek alternative sources of security.