Academic journal article The Journal of Law in Society

Finding Clout: Repositioning Municipalities in the Banking Market

Academic journal article The Journal of Law in Society

Finding Clout: Repositioning Municipalities in the Banking Market

Article excerpt


American municipalities have a lot of cash but not a lot of clout in the local banking markets. Collateralization rules in most states means that only the biggest banks are interested in the deposits of even the smallest cities and yet those are the institutions least likely to loan those deposits within the borders of the investing municipality. It is possible to create an intermediate institution to accept municipal deposits and reinvest them in local banks. Such a structure would allow municipal deposits to be broken up into units small enough for any bank while avoiding the administrative burden on city bookkeeping. This would tend to redirect public funds to local investment and can reduce pressure on government budgets. Such an institution would be a natural place to launch local lending initiatives, and could provide a platform for a variety of programmatic initiatives to increase local economic activity or to consolidate services among a group of municipalities. Institutions like this can also be a concrete step forward in the attempt to inject consideration of the public good into the financial system, as well as a way to alleviate some of the financial pressures on municipalities.

What is the Problem?

American municipalities across the country keep a great deal of cash in their local bank. The Census Bureau counts 35,879 municipalities in the United States, many of which possess daily cash balances of several millions of dollars. (1) Even a fairly small town of 10,000 people is likely to have more than a million dollars in the bank much of the time, and this count of municipalities does not include the nation's 3,031 counties, 12,880 independent school districts, or 38,266 special districts. (2) Collectively, county and municipal governments control over $1.6 trillion in cash and securities. (3) Putting aside pension funds still leaves over $637 billion as of 2012. (4)

Though municipal deposits are valuable for many banks because of their volume and their predictable ebb and flow, (5) there are drawbacks to accepting these deposits. One is the volume of small transactions that make up these deposits. Government is an enterprise with many small payments going in and many small payments going out, comparable to a utility company in some ways, but with a larger and far more diverse collection of employees and business lines. (6) A city government will accept tax payments, but might also accept water bill payments, permitting fees, license fees, sewer fees, court costs, rental payments, bus and transit fares, zoo admission fees, and more. (7) This is a drawback largely addressed by ample transaction fees, but still requiring substantial logistical support--dropbox service, night deposit locations, cash delivery--for a bank to manage.

The other, and more significant, drawback to a bank accepting municipal deposits is the existence of collateral requirements. (8) Even a small town's bank account balances are likely to be far in excess of the FDIC insurance limits. (9) Many states, if not most, have laws requiring banks who accept such deposits to put up some level of collateral against them. (10) Rules vary among the states. (11) In Rhode Island, state law requires banks to collateralize 100% of deposits with maturities over 60 days, (12) while in California, they must put up collateral equal to 110% of all deposits. (13) In Texas, all deposits are collateralized at 100% except for school districts, where the requirement is 110%. (14) In many states, it is common for municipal ordinances and local policy to create stiffer rules. (15)

The question for any bank that wishes to serve a municipality is where do they get the collateral? Purchasing collateral-grade securities with a customer's deposits is the activity of money-market funds, but seldom a workable strategy for a bank whose business model depends on finding higher returns for its deposits than are available with collateral-grade securities. …

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