Once In the Bank, Are Public Funds Safe?

By Barbara T. Reid

As any auditor will advise, processing receipts, whether in the form of cash or checks, poses inherent risks of mishandling. Without proper internal controls, revenue accounts may not reconcile for a variety of reasons. That is why significant attention is paid during the audit process to the policies and procedures dealing with revenue collection operations throughout all municipal departments handling these types of transactions. However, even with tight controls over collection, deposit and accounting functions, a municipality’s responsibility for safeguarding public funds does not end by depositing the money in the bank. Additional steps are necessary to insure the continued safety and security of all public funds.

Limitation of FDIC Insurance
The Federal Deposit Insurance Corporation (FDIC) provides insurance coverage of public funds to protect these funds in the event of a bank failure. However, the amount of insurance coverage is limited and depends upon the type of deposit and the location of the insured depository institution. All time and savings deposits owned by a public unit and held by the same official custodian in an insured depository institution within the state in which the public unit is located are added together and insured up to $100,000. Separately, all demand deposits owned by a public unit and held by the same official custodian in an insured depository institution within the state in which the public unit is located are also added together and insured up to $100,000. For the purpose of these rules, the term “savings deposits" includes NOW accounts, money market deposit accounts and other interest-bearing checking accounts.

For deposit insurance purposes, the term “public unit" includes a state, county, municipality or “political subdivision" thereof, which would include school districts and village districts. Under FDIC regulations, the “official custodian" of the funds belonging to the public unit—rather than the public unit itself—is insured as the depositor.

The term “political subdivision" also includes any subdivision or principal department of a public unit (state, county or municipality) if the subdivision or department meets the following tests: (1) the creation of the subdivision or department has been expressly authorized by the law of such public unit; (2) some functions of government have been delegated to the subdivision or department by such law; and (3) the subdivision or department is empowered to exercise exclusive control over funds for its exclusive use.

Under the criteria described above, it appears that accounts held by the Town/City Treasurer, (as the official custodian of municipal funds) would be insured separately from the accounts held by the Trustees of Trust Funds (as official custodians of trust funds) and separately from the accounts held by Library Trustees (as official custodians of library funds). However, the FDIC regulations note that the term “political subdivision" does not include subordinated or non-autonomous divisions, agencies or boards within the municipality.

Per the FDIC regulations, an “official custodian" is an officer, employee or agent of a public unit having official custody of public funds and lawfully depositing the funds in an insured institution. In order to qualify as an official custodian, a person must have plenary authority—including control—over the funds. Control of public funds includes possession as well as the authority to establish accounts in insured depository institutions and to make deposits, withdrawals and disbursements.

So, under the FDIC regulations described above, it appears that funds held by the Town/City Treasurer, by the Trustees of Trust Funds and by the Library Trustees would each be insured up to $100,000 for time and savings deposits with an additional $100,000 insurance coverage for demand deposits. Note, however, that deposit insurance coverage cannot be increased by dividing funds among several putative official custodians who lack plenary authority over such funds. Likewise, coverage cannot be increased by dividing funds among several accounts controlled by the same official custodian for the same public unit.

But for most municipalities, the cumulative balances in these accounts far exceed $100,000. Therefore, the additional step of collateralizing funds that are not protected by FDIC insurance coverage needs to be taken to continually insure the security of these funds.

Perfecting Collateral Agreements
Collateralizing public funds is a process by which banks may pledge assets to fully secure a municipality’s deposit amount in excess of the FDIC insurance limit. FDIC recognition of these assets as pledged to a specific municipality in the event of a bank failure depends on whether the collateral agreement meets certain requirements. In order to perfect the collateral agreement in the eyes of the FDIC, a municipality must insure that the collateral agreement: (1) is in writing; (2) is approved by the board of directors of the depository institution or its loan committee, with approval reflected in the minutes of said board or committee; and (3) is continuously, from the time of its execution, an official record of the depository institution.

If the collateral agreement does not meet the three criteria listed above, then the FDIC may void the security interest, leaving the municipality with only the right to share with other creditors in the pro rata distribution of the assets of a failed institution.

Through interpretive letters, the FDIC has provided further guidance regarding the requirement for board of director’s approval of collateral agreement. In essence, the FDIC has said that the board of directors does not need to approve every collateral agreement, but may delegate this responsibility by authorizing a particular officer and by setting parameters regarding the type and dollar amount of collateral contracts to which said officer may bind the institution. Such a delegation should be in the form of a corporate resolution and be an official record (that is, in the board minutes) of the institution.

The Government Finance Officers Association (GFOA) has recently revised its recommended practice regarding collateralization of public deposits. The GFOA recommends that all pledged collateral be held at an independent third-party institution and evidenced by a written agreement in an effort to satisfy the Uniform Commercial Code (UCC) requirement for control. The UCC states that the depositor does not have a perfected interest in a security unless the depositor controls it. Control means that swaps, sales and transfers cannot occur without the depositor’s written approval. GFOA also recommends that the value of the pledged security be in an amount equal to at least 102 percent of the deposit level.

These procedures regarding collateral, and the steps necessary to perfect the collateral agreement, should be an integral part of a municipality’s investment policy adopted in accordance with RSA 41:9, VII for towns and RSA 47:6, II for cities.

Steps to Assure Perfected Collateral
Municipalities, not the banks, are responsible for insuring the safety of all public funds under their control. To fulfill this responsibility, it is recommended that municipalities determine whether public funds exceed the FDIC insurance coverage limits, and if so, whether appropriate collateral agreements are in place to protect these uninsured funds. To document compliance with the FDIC criteria regarding perfected collateral agreements, municipalities should obtain a copy of the minutes of the board of directors or loan committee, or the delegation resolution adopted by either the board of directors or loan committee, approving the pledge of collateral.

Barbara Reid is Government Finance Advisor for the New Hampshire Local Government Center.

Information for this article was provided by the FDIC at the New Hampshire Government Finance Officers Association (GFOA) annual conference in May 2008. Additional information on this subject is available on the FDIC Web site at www.fdic.gov/deposit/deposits/factsheet.html. The GFOA recommended practice regarding collateralization of public deposits, along with numerous publications on public fund management, are available on the GFOA Web site at www.gfoa.org.

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