Client
Promontory Interfinancial Network
Project
Financial Services/Information Technology
Executive Summary
US banks have long been encumbered by the $100,000 cap on
federal deposit insurance. Now a new mechanism lets them swap deposits,
effectively extending insurance coverage and making them much more competitive.
Download the full case study (PDF, 167K)
PDF Help Passing the Bucks By Charles Ward Outlook Journal, October 2003
Remember Sir Joseph Wilson Swan? He was the other inventor
of the electric light bulb. While Swan and Thomas Edison filed their patents
within a year of each other, it was Edison who more clearly understood—and
acted upon—the commercial potential of the new invention. Swan was knighted for
his contributions to science; Edison’s various companies eventually counted
their customers in the millions. The fact is, the history of business is mostly
unforgiving of second-to-market entries.
So when a team of banking industry leaders came up with the
idea to create a network mechanism to allow participating US banks to share and
extend among themselves one of their strongest competitive
advantages—government-backed deposit insurance—they knew they wanted to get it
up and running quickly. The concept was to help the nation's 9,500 community
banks address a decades-old problem—that Federal Deposit Insurance Corporation
coverage on individual accounts is capped at $100,000 per account—by enabling
them to swap their deposits over that amount. It would be the first time that
community banks across the country had a way to offer their customers FDIC
insurance on larger accounts.
“We thought it was a good idea, but thought someone else
might think so too,” recalls Alan Blinder, former vice chairman of the board of
governors of the Federal Reserve System and now vice chairman of the new
company, Promontory Interfinancial Network. “If you discover oil in your
backyard, you can fairly assume it will be there next year. Ideas are not like
that.”
From that sense of urgency, Promontory was conceived, built
and launched in just 20 months. The company was formed by Eugene Ludwig, former
US Comptroller of the Currency and vice chairman of Bankers Trust Corporation;
Mark Jacobsen, former chief of staff at both the Office of the Comptroller of
the Currency and the FDIC; and Blinder. The team combined its knowledge of the
banking industry with the technical expertise of its development partner,
Accenture. The achievement—of instant scale, first-to-market arrival and
reliability—is notable because Promontory created not only a company but its
own market category, for the Certificate of Deposit Account Registry Service,
or CDARS.
  There
was a clear market need for CDARS. Bankers throughout the country had been
asking Congress to raise the $100,000 FDIC insurance limit for years, and
customers in search of the security of coverage for larger amounts had been
forced into increasingly convoluted means of getting it. For example, some
individual depositors placed their funds at multiple institutions in $100,000
increments, a labor-intensive exercise that dilutes customer loyalty to a
specific bank. Municipalities are obligated to require banks to pledge
securities as collateral for any uninsured funds, a practice that is costly for
banks, so the yield they offer municipalities is lower. Nonprofit groups,
trusts and retirement plans were also constrained by the $100,000 cap.
Corporations in need of secure liquidity often bypassed banks entirely, turning
to Treasury bills and other avenues to meet their cash management needs.
The dramatic rise of money-market mutual funds run by large
money-center and investment banks compounded the erosion of smaller banks’
share of the customer wallet. The technology revolution in US financial
institutions brought great efficiency and economies of scale to money-center
banks, which were therefore able to attract more and more business from
community and regional banks. Although the United States’ nearly 9,500 smaller
banks held more than $3 trillion in deposits in 2002, that figure represented
just 25 percent of total deposits, half of what the small banks held in 1975.
The issue was not only market share. The shift of deposits
out of communities to, in effect, the national capital markets had become a
threat to the financial stability of individual community banks. “Core deposits
are the straw without which you can’t make the bricks of lending,” notes
Ludwig, Promontory’s chairman and CEO. “The community banks have seen their
loan-to-deposit ratios get markedly worse.” Community banks are vital to the
towns they serve, because they provide liquidity for local lending to small
businesses and consumers.
CDARS, Promontory’s new financial service, was conceived as
a straightforward response to all these conditions. It enables member banks to
offer customers FDIC coverage for multimillion-dollar deposits. When a bank
joins the Promontory network, its customers can create a portfolio of CDs; each
of the CDs is distributed to other network banks in increments of less than
$100,000. A recipient bank sends back an equal amount of funds through CDARS,
which allows the entire transaction to be booked as a deposit at the
originating bank. Customers may choose among the network banks for their CDARS
funds, but the entire chain of transactions is seamless to them. Importantly,
the customer relationship stays with the primary bank, as no confidential
financial information is forwarded to the other banks.
Collecting local deposits is the most inexpensive way for
banks to fund their balance sheets. Participating banks base their CDARS
interest rates on local conditions, as they do for any other CD, and they pay
for Promontory’s service only to the extent they use it. So, with CDARS,
customers obtain security and convenience, banks obtain stable funding and
customer relationships, and communities gain access to more funds for local
borrowing. “From a public policy and macroeconomic perspective, this is the
kind of thing we want to help lubricate our economy,” says Ludwig.
The benefits of the CDARS idea seemed self-evident to its
creators. Given the inherently conservative nature of community banking,
though, Promontory needed to make a case for the safety, soundness and
integrity of the system. To that end, it recruited a board of well-known
figures from banking and the regulatory community, which conveyed both
experience and integrity. In addition to Ludwig, Blinder and Jacobsen, the
Promontory board includes two former FDIC chairmen, William Seidman and William
Isaac; Edward Kelley Jr., recently retired from the Board of Governors of the
Federal Reserve; and former US Senator Warren Rudman.
In addition, Ludwig actively invited feedback about the
CDARS idea from banks. He particularly sought out banks that—because of their
geographic dispersion, base of business experience, organizational structure or
customer mix—would provide specific kinds of pre-launch input. Promontory’s
board composition, the outreach effort and the pre-launch testing of the CDARS
system were instrumental in obtaining the endorsement of the American Bankers
Association in early 2003.
Accenture, which had already worked on a number of similar
projects, was approached and hired in August 2001. Promontory’s funding
partner, one of the world’s premier clearing banks, was well aware of
Accenture’s role in managing the launch of FXall, an electronic foreign
exchange portal. Accenture had also launched IntercontinentalExchange, a
business-to-business commodities exchange, bringing the platform to market in
just six months.
Working with Promontory’s well-developed business plan, an
Accenture team led by partner Chip Tsantes built out the design for the
underlying CDARS technology platform over a 10-month period. Once the details
of the plan were finalized and funding was secured, Promontory and Accenture
opened the development throttle. Promontory owned no technology itself, so it
relied upon Accenture to procure, customize, install and test its new system.
Building from Scratch
The
build-out phase—design, installation, testing and implementation—took just 26
weeks, and CDARS launched in January 2003. “We walked into an empty building,
and six months later, we were transacting the first live CDARS,” says
Accenture’s Tsantes. “Fortunately, we had the luxury of building from scratch,
which meant we could create the system with a B2B information exchange at its
core.”
The CDARS platform uses some off-the-shelf components, such
as a generic reporting package and sign-on pieces, and employs customized
software to integrate systems for core transactions, reporting, security and
accounting. Security is a critical aspect of the system, reflecting the
paramount importance of the safety and privacy of data, both for the customer
and the participating banks. Reliability was another pre-launch concern of the
target banks, and so the CDARS technology platform was designed with system and
function redundancy throughout.
Because the value of the Promontory network increases with
expanded membership, quickly reaching critical mass of membership was a
priority. Accenture developed training, operations and marketing modules in
tandem with the technology installation to address both customer-facing issues
and back-office issues. Banks can join the network and be online the same day.
The entire system has been designed for intuitive ease of use. “Banks require
the utmost in reliability and security, but at the same time, they place a
premium on ease of use,” says Jacobsen, Promontory’s president and COO. “We set
out to accomplish both: a state-of-the-art system that exceeds all bank
regulatory guidelines while still being simple to use.”
There are 9,500 banks in Promontory’s target universe.
Today, six months after launch, more than 500 of them are committed to the
CDARS network. The combined assets of Promontory’s target banks would make it
one of the largest banks in the United States.
The advent of the CDARS service has allowed community banks
to focus on their two chief competitive advantages—FDIC coverage and local
relationships. The need by both household and business investors for greater
security, particularly after the stock market crested in March 2000, has only
highlighted these strengths. “Community banks, in the end, are relationship
institutions, not processors of money,” notes Ludwig. “CDARS is aimed at
helping them reclaim their footprint in the economy.”
 Charles Ward is a New York-based
business writer.
Back to
Contents
To Top |