BPInsights: January 14, 2023

A Small Crypto Gateway to the Banking System

Silvergate Bank, whose business model catered to the crypto industry, tapped Federal Home Loan Bank advances to weather the crypto crash. Silvergate received $4.3 billion in secured FHLB loans late last year, according to American Banker. The bank suffered a run on deposits in the wake of FTX’s collapse. While FHLB loans are a commonplace way for smaller banks to close a liquidity gap, the link between the FHLB system and the crypto crash hints at an opening for future crypto contagion to breach the banking system, according to the American Banker.

  • Context: The FHLBs are a product of the Great Depression, originally designed to support housing finance. But now their role has become broader, and their advances often provide funding to banks of all sizes (not necessarily a cause for concern). The Federal Housing Finance Agency is reviewing their role.
  • Contagion risk?: Silvergate’s use of the FHLB advances was permissible, but illustrative of crypto’s connection into the regulated banking system and of the FHLBs’ straying from their original purpose. “[J]ust because everything is above-board doesn’t mean that this episode doesn’t shine a bright light on how the Home Loan Bank System is being used in ways that are wildly divergent from their original intended purpose on the one hand and how staggering losses from cryptocurrency investments are finding their way back to traditional finance on the other,” American Banker’s John Heltman wrote in a column.

Five Key Things

1. Powell: Fed Isn’t ‘Climate Policymaker’

When it comes to climate risk, the Fed will stay in its lane, Federal Reserve Chair Jerome Powell said this week. “[W]ithout explicit congressional legislation, it would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals,” Powell said during a panel discussion in Sweden. “We are not, and will not be, a ‘climate policymaker.’” He also said decisions about policies to address climate change directly should be made by elected branches of government.

  • Narrow niche: The Fed’s limited role in overseeing climate risk falls under its purview as a bank supervisor, Powell said. “The public reasonably expects supervisors to require that banks understand, and appropriately manage, their material risks, including the financial risks of climate change.”
  • Bowman: In a separate speech in Florida, Governor Michelle Bowman expressed a similar sentiment. “The Fed views its role on climate as a narrow focus on supervisory responsibilities and limited to our role in promoting a safe, sound and stable financial system,” Bowman said.

2. OFR Calls for Transparency on Crypto Firms’ Assets to Monitor Funding Strains

The Office of Financial Research this week flagged the need for regulators to see data on assets held by crypto and stablecoin firms. This data would help regulators monitor any problems in commercial paper markets from rapid stablecoin withdrawals. Regulatory data on assets held by stablecoin and crypto lenders “would be an essential input to monitoring this risk,” the OFR said in its annual report to Congress. Disturbances in that market could disrupt funding for businesses issuing short-term debt.

  • CBDC strains: In addition, the OFR reiterated that “CBDCs should be immune to the run risk of stablecoins but may increase flight-to-safety concerns,” referring to the risk that investors pull money out of bank deposits and into CBDC during market stress.

3. Paper: Stop Treating Crypto Like Traditional Finance

A recent paper by Columbia University’s Todd H. Baker breaks down a fundamental misunderstanding that could thwart regulators’ attempts to keep the financial system safe from crypto risks. “Despite the dress up clothes it wears, crypto trading isn’t ‘economically similar’ to any part of the traditional financial system and serves none of the productive purposes that define finance,” Baker wrote. “That’s because crypto trading isn’t finance or financial services at all. Crypto trading is as a game emulating finance. Or, perhaps more accurately, a gambling game emulating finance.” Policymakers should prevent financial contagion by cordoning crypto off from the regulated financial system and creating a separate, non-financial regulatory regime to oversee it, he recommended.

4. CFPB Ramps Up Nonbank Scrutiny With Proposed Terms and Conditions Registry

The CFPB this week proposed a new nonbank database for terms and conditions in customer contracts. The move marks the Bureau’s latest clampdown on nonbank financial firms after it proposed a rule in December to create a “repeat offender” registry of nonbank providers. This week’s proposal would require nonbanks subject to CFPB oversight to submit information on terms and conditions in customer contracts that “seek to waive or limit individuals’ rights and other legal protections.” That information would then be published in a public registry. One implication of the proposal: It could pressure nonbanks into rewriting customer agreements voluntarily.

5. BPI’s Bill Nelson Explains the Discount Window on Bloomberg’s ‘Odd Lots’

BPI Chief Economist Bill Nelson joined Bloomberg’s Odd Lots podcast this week to break down what the discount window is, why it suffers from stigma and what it means in the banking system. He also put the discount window in context of the Fed’s quantitative tightening: “It becomes especially important for the Fed that everybody sees the discount window as a viable source of short term funding when the Fed is shrinking, when they’re reducing the size of the balance sheet,” he said. “For the Fed to get as small as it wants to be, banks have to reduce their demand for those deposits at the Fed. And one way to do that is make them comfortable with the idea that, well, if you really need money at the end of the day, and you happen to surprisingly come up short, you can always use the discount window. It’s kind of like if you have a checking account that has overdraft protection versus one that doesn’t, you’re probably going to be happy running a lower balance with on the one with the overdraft protection.”

To learn moreListen to the episode here.

In Case You Missed It

Op-Ed: Congress Should Have More Say in Bank Capital Decisions

A “race to the top” in global bank capital requirements could harm the U.S. economy, Americans for Tax Reform’s Bryan Bashur wrote in a recent American Banker op-ed. The Basel III standards’ significant implications for the U.S. economy require Congressional authorization, Bashur wrote. He also observed that Vice Chair for Supervision Michael Barr did not acknowledge any downsides to higher capital requirements in a recent speech and that the Federal Reserve relies too heavily on Basel Committee standards instead of Congressional direction. “This is a clear example of the committee circumventing elected representatives and directly imposing policies on American regulators that could end up restricting access to capital for all Americans,” Bashur wrote.

The Crypto Ledger

The Fed and other agencies are monitoring crypto activities in the banking system, but regulators should support innovation and “recognize that the banking industry must evolve to meet consumer demand,” Federal Reserve Governor Michelle Bowman said in remarks this week. The remarks came shortly after the banking agencies urged banks to be wary of crypto activities in their business models. Here’s what else is new in crypto.

  • SEC charges Genesis, Gemini: The SEC this week charged Genesis Global Capital LLC and Gemini Trust Company LLC for allegedly offering unregistered securities to retail investors through the Gemini Earn crypto lending program, under which investors could lend their crypto assets to Genesis in exchange for Genesis’ promise to pay interest.
  • FTX assets: Bankrupt crypto exchange FTX has identified $5 billion in liquid assets, including cash, securities and liquid cryptocurrencies, according to its attorneys. It’s still unclear how big the shortfall is between what FTX owns and what it owes.
  • Binance/Voyager: Bankrupt Voyager Digital received initial approval to sell its assets to Binance.US, but the deal still faces hurdles ahead, including a CFIUS national security review. Separately, Binance Holdings Ltd. this week acknowledged that maintaining the backing of its Binance-peg BUSD token “has not always been flawless.”
  • Coinbase layoffs: Coinbase announced this week that it would lay off about 20 percent of its staff in efforts to cut costs. The firm indicated that compliance staff will largely be spared.
  • Crypto in court: Damian Williams, the U.S. Attorney for the Southern District of New York leading a case against Sam Bankman-Fried, was profiled in the Financial Times this week as a prominent player in crypto enforcement.

House Financial Services Committee Republicans Announce Assignments

The House Financial Services Committee this week announced subcommittee assignments now that Chair Patrick McHenry (R-NC) has taken the gavel. Rep. Ann Wagner (R-MO) will chair the Subcommittee on Capital Markets; Rep. Andy Barr (R-KY) will lead the Subcommittee on Financial Institutions and Monetary Policy; Rep. French Hill (R-AR) will lead the newly created Subcommittee on Digital Assets, Financial Technology and Inclusion; Rep. Blaine Luetkemeyer (R-MO) will head the Subcommittee on National Security, Illicit Finance and International Financial Institutions; Rep. Bill Huizenga (R-MI) will lead the Subcommittee on Oversight and Investigations; and Rep. Warren Davidson (R-OH) will chair the Subcommittee on Housing and Insurance.

Wells Fargo Launches Strategic Plans to Streamline Home Lending Business

Wells Fargo this week announced strategic plans to simplify its mortgage lending business aimed at serving bank customers and minority communities. The bank is exiting the correspondent business and plans to reduce the size of its servicing portfolio. Wells Fargo will also optimize its retail team to focus primarily on bank customers and underserved communities; invest an additional $100 million to advance racial equity in homeownership; and deploy additional home mortgage consultants in local minority communities, among other steps.

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The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.