If Your Bank Is Your Escrow Agent, It May Be Time For A Change

Traditional escrow solutions can be inflexible and unable to service complex sectors, making independent providers more valuable than ever.

Should traditional banks still serve as escrow agents? Increasingly complex arrangements, high interest rates, and recent bank failures might be the wake-up call the industry needs to answer this question.

While many depositors in a variety of industries still use traditional escrow accounts in which the bank and escrow agent are the same institution, it’s becoming increasingly clear that these arrangements can be risky for depositors when problems occur at the bank, and even at calm times, they can limit one’s ability to maximize returns.

How traditional escrow agreements limit the potential for maximizing interest

The traditional escrow relationship goes like this: your bank acts as escrow agent and opens an account at the bank to hold funds, which are not released until the escrow agent (in this case the bank) has satisfied its requirements.

Escrow agreements can help reduce risk in a variety of scenarios. An escrow account is required in sectors like 1031, while in others, like EB-5, it has become a best practice. Sectors like Venture Capital and Private Equity benefit from escrow structures that provide additional security when parties are located in different jurisdictions, both during capital deployment and distributions.

But what happens to the funds while they are in the escrow account? For example, once EB-5 investor funds are placed in an escrow account, it may be some time before they are deployed to the project. During that period, these funds can earn interest. If the bank offers solid interest rates, this can improve investor returns.

But what if another bank offers much better rates for the same type of account? If your escrow agent is also your bank, you’ll be tied to that institution and will be unable to take advantage of better rates. But with an independent escrow agent like JTC with a wide range of banking partners, funds can be deposited at different banks in ways that can benefit the client, including taking advantage of higher interest rates or obtaining more favorable loan terms.

While this is one way in which an independent escrow agent can improve returns while traditional bank escrows cannot, there are also much more serious scenarios that depositors need to prepare for.

Bank takeovers and escrow – what do you do when your bank fails?

Imagine you were a depositor at Silicon Valley Bank (SVB) in March 2023. When the bank failed, the Federal Deposit Insurance Corporation (FDIC) extended deposit insurance to amounts in excess of $250,000. This was good news to anyone who had large deposits at SVB. They could then move their money, right?

Not exactly. If your funds were in an escrow account with SVB, there would be an extra layer of complexity. The escrow agreement with SVB (an entity which no longer exists the way it used to) would need to be terminated, or SVB would need to resign (which they might be loath to do since they want the deposit run to stop and may be slow to react due to the chaos happening around them). You’d also need to sort out FDIC insurance, finding a new escrow agent and bank, and establish new agreements both with your new escrow agent and with all other parties involved in the original agreement. Suddenly, it’s not so easy to move your money anymore.

An independent escrow agent like JTC is shielded from changes in bank policy because we can move funds whenever necessary to one of our other banking partners. Our clients can utilize a variety of different banks and obtain 100% FDIC coverage, and if any of those banks should fail, we can act quickly to ensure deposited funds are secure.

This is especially important in sectors like EB-5 where lost or inaccessible funds could affect an investor’s immigration status. EB-5 and its escrow structures are complicated, and require specific expertise, which is why many traditional banks won’t get involved.

Complexity as a hurdle for traditional banks

Banks like SVB or Signature Bank, both of which experienced federal takeovers in 2023, were regional banks that specialized in certain sectors – SVB specializing in venture capital and Signature in EB-5. Depositors in those industries went to regional banks instead of larger institutions because of the expertise required to understand those sectors.

Traditional banks are built to service vast numbers of clients across many sectors – and, because of the regulatory regimes in which they operate, they must maintain high levels of controls over all their processes. This means they’re better off standardizing the way in which certain services, like escrow, are delivered, despite pressure to meet their clients’ increasingly specialized needs. The EB-5 Immigrant Investor Program, for instance, has escrow triggers related to a highly complex immigration process that traditional banks often struggle to understand.

Institutions like SVB or Signature Bank can develop the expertise in a particular sector or transaction type to meet these needs and fill the void. But as we’ve seen, these banks, which are smaller and concentrated in specialty sectors that are more exposed to market adjustments, come with potentially significant risks of their own.

There are other challenges for traditional banks when it comes to escrow. As a recent American Banker article notes, these institutions grapple with everything from disbursing money to “manually performing complex interest calculations” – that is, between the entity holding the funds and the beneficiary – and “splitting requirements for subaccounts.” It’s perhaps no surprise that in recent years several large banks have faced class action lawsuits alleging that they failed to pay out the legally required 2% interest on mortgage holders’ escrow accounts.

“Core systems within banking are really good at handling access and management and compliance when one entity is holding the money and it’s that entity’s money,” Nathan Baumeister, CEO of ZSuite, which created a digital escrow solution alongside five community banks, told American Banker. “They are not good at managing that third party relationship between the trustee and the beneficiary.”

ZSuite’s collaboration with these banks provides a useful model: traditional players working with fintechs and/or other third parties to provide the customization, digitization, and expertise their customers crave, leaving the banks to focus on what they’re best at. This is only becoming more important as consumers demand more personalized digital solutions and high interest rates as recent bank failures put the spotlight on cash management.

There are sectors like EB-5 that larger banks refuse to enter, but even in industries where a larger bank can be used, independent third parties can offer greater flexibility when it comes to movement of funds and diversification of financial institutions.

JTC has expanded its escrow services for both public and private companies as well as institutional and private clients to include solutions in areas such as wire transfers, indemnity deposits, collection of split fees from joint ventures, litigation and arbitration awards, and private transactions involving family offices. Regardless of the sector in which you operate, JTC’s independent escrow agent services can help you mitigate financial risk by offering third-party protection, flexibility, and industry expertise to ensure deposits are safe, accessible, and placed in the right accounts to help your business thrive.

Learn more about JTC’s escrow services