Highlights
- House starts investigating debanking of crypto firms
- Are banks or regulators to blame?
- Regulators repeatedly warned banks about the crypto sector
- Timing matters: actions before shuttering of Silvergate, Signature deserve more attention
- Are there parallels with SAB 121 – informal guidance acting as rules.
On Friday Congressman James Comer sent a letter to several crypto-linked firms asking them about their experience with debanking. He wrote as Chair of the House Committee on Oversight and Government Reform, the same committee that investigated Operation Choke Point under the Obama administration, in which dis-favored industries struggled with bank accounts.
One of the goals is to establish the extent to which the authorities are responsible versus the banks themselves. That aspect will inevitably provide nuanced results. Ironically, it is this debanking behavior that has encouraged the adoption of crypto by some, though the sector is becoming subject to similar rules.
On several occasions regulators warned the banking sector about the risks of getting too much exposure to cryptocurrency businesses or conducting cryptocurrency activities. Part of that may have been driven by a dislike for the sector. But it was also because of the volatility of cryptocurrencies and a desire to protect banks and mainstream depositors from suffering losses.
When authorities make warnings like that, and take actions such as obstructing banks from offering crypto, at some point involvement becomes a hassle for banks. In fact, the FDIC disclosure of its crypto letters to banks exposed precisely this friction. Banks start to weigh the costs and benefits.
Regulators provide cover for bias
At the same time, this sort of thing provides cover for those that also have political motivations. There’s the example of UK politician Nigel Farage who was debanked by Coutts. The bank initially hid behind various excuses until political bias was exposed as the true reason. There was another contributory factor: Mr Farage was no longer that significant a client.
Congressman Comer’s letter notes that Melania Trump was also debanked. Notably it does not mention Donald Trump. Why? Perhaps because they have different sized bank balances. Banks are businesses and make a cost benefit trade off regarding whether the amount is worth the effort. The Trumps would be considered politically exposed persons under anti money laundering (AML) rules, which creates yet another hassle factor for banks.
Ledger Insights has frequently been critical of the high costs of simplistic AML rules. Pointing out the hassle factor is not giving banks an excuse, it is simply highlighting a fact. I have personally been debanked (unrelated to crypto), so have first hand experience.
Does the timing matter?
Potentially the timing matters for these investigations, with two dates in particular. March 2023 saw the crypto sector simultaneously lose the two banks that most catered to them, with other banks unwilling to take up the slack, partly because of pressure from regulators. On the one hand, this was the time that crypto companies most needed new banking services. On the other hand, the rapid drawdown of crypto deposits at two specialist banks highlighted the risks to banks – some exposure was acceptable, but not too much.
Another relevant date is May 2022. Before that, the volatility of cryptocurrencies were obvious. After the collapse of the Terra stablecoin in early May, crypto lenders started dropping like flies, with several high profile bankruptcies. The risks became more tangible.
Regulators will argue these dates are not relevant as the risks were there already, they had simply not manifested. And the whole point of risk management is anticipation.
Many of the examples in Congressman Comer’s letter are since March 2023. Senator Toomey wrote to the FDIC raising concerns regarding Choke Point-like behaviors relating to the crypto sector in 2022 before his retirement. He highlighted that acting FDIC Chair Gruenberg had led the FDIC during the original Choke Point activities. Gruenberg took office in February 2022.
Parallels with SAB 121
In addition to a parallel with the original Operation Choke Point, there’s also one with the SEC’s SAB 121, the accounting rule that prevented banks from providing crypto custody, which has just been rescinded. Lawyers Cooper Kirk note that in Choke Point 2.0 regulators were “imposing binding requirements on the banking industry through informal guidance documents.”
Cooper Kirk encouraged Congress to investigate Choke Point 2.0 and alleged other matters they consider illegal, including:
- it deprives business of their constitutional rights to due process
- it deprives Americans of constitutional protections against the arbitrary exercise of governmental power
- regulators exert their power over banks to pick and choose the customers whom the banks may serve
- State banks that are statutorily entitled to access the federal reserve system are being denied their rights solely because they serve the crypto industry
- regulators are acting in an arbitrary and capricious fashion by failing to adequately explain their decisions.
Concentration and risks
A major contributor to crypto debanking is concentration risks. Two banks that catered to the sector were wound down (Silvergate) or shut down (Signature) in March 2023. Other banks didn’t want to have too much exposure to the sector because they were warned by regulators not to. As a result, it was hard to find banks that were willing to pick up the slack.
An unpopular view is that the cryptocurrency community had a hand in the shuttering of the two banks. In both cases the crypto sector rapidly pulled cash out of the banks at short notice and en masse. Banks are not designed for that, although Silvergate did a pretty good job of managing the $8 billion draw down. The fact that Silvergate was FTX’s bank created the cloud that led to it voluntarily winding down.
In Signature’s case, the panic triggered by the collapse of Silicon Valley Bank caused crypto clients to withdraw their cash a bit too quickly. Signature board member and former congressman Barney Frank complained that the FDIC was wrong to shut it down. The crypto-triggered run meant that Signature’s bank ratios were not healthy and it wasn’t allowed the time to refinance its real estate portfolio.
These cases of rapid flight of crypto bank balances gave regulators some legitimate concerns. In part, that led to the subsequent void.
Cryptocurrency is a relatively new industry which is perceived as risky both because of its volatility and exposure to potential AML issues. Hence, there is a banking learning curve required to understand how to manage the risk.
The banks most likely to be willing to do that are those that want to target the crypto sector as a client base. But regulators don’t want the risk concentration, so they aren’t keen on specialist banks.
Addressing risks transparently
The Financial Stability Board and global regulators have long warned of the risks of cryptocurrency if it became too interconnected with the core banking system. Given the volatility of cryptocurrency and the heavy use of leverage, cryptocurrencies pose actual risks.
When the SEC rescinded SAB 121, they didn’t just say banks should ‘have at it’ with crypto custody. They said banks need to assess the risks and quantify a contingent liability – a sensible approach.
In Europe, stablecoin issuers have to hold a significant proportion of assets at banks because the EU does not have such a large market for Treasuries. To reduce the risks to banks, stablecoin issuers must distribute their reserves across many bank accounts.
Like these examples, it’s now time to take a constructive and transparent approach to managing the risks, rather than underhand delaying tactics and regulators hoping the sector will go away.
