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Using Federal Mortgage Bank advances to offset losses on crypto deposits raises questions about banks’ reliance on quasi-government funding mechanisms for liquidity.
La Jolla, Calif.-based Silvergate Bank and New York-based Signature Bank are arguably the two traditional banks with the most exposure to the digital asset industry, with mortgages following the collapse of cryptocurrency exchange FTX. Take advantage of banking advances.
Of the two, Silvergate, which has shifted the majority of its operations to digital assets over the past decade, has been more affected by the volatility associated with the demise of FTX.received by the bank $4.3 billion upfront Set off from the Federal Mortgage Bank of San Francisco in Q4 2022 $8.1 billion in deposits withdrawnUpfront payments now account for over 60% of Silvergate’s wholesale funding.
This episode spotlights both the oversight of cryptocurrency activity in the banking sector and the use of advance payments to support institutions that support little housing finance.
“The fact that this bank, which had been exposed to steep cryptocurrency losses, was entangled with the Federal Home Loan Bank is the first indication that the real financial system and cryptocurrencies may be somehow interrelated. As a professor at the Wharton School of Business at the University of Pennsylvania puts it: “It’s not surprising that banks are correlated with fairly hidden means of covering their liquidity needs. , in my view, is a bit worrying.”
At the heart of the debate is whether the Federal Mortgage Bank of San Francisco provided advance payments to Silvergate simply to stick to its mandate of providing liquidity to member banks, or to the companies involved. That is, did it provide de facto relief? In dangerous and unproven business areas.
Ryan Donovan, chairman and CEO of the Federal Home Loan Banking Council, an organization that serves as the voice of the entire federal mortgage banking system, said advance payments will be the primary source of capital for member banks. said it was intended to As long as companies can provide suitable assets as collateral, mortgage banks have an obligation to provide liquidity, Donovan said.
“Mortgage banks are not an urgent source of liquidity. There is a perception that if an institution needs liquidity, they are somehow in trouble, but liquidity issues are not part of the normal course of business. can occur for a variety of reasons,” he said. “We were established by Congress to meet the needs of banks in such circumstances.”
In fact, advances are often the first place many banks look for liquidity in a pinch.Federal Reserve Board Latest Survey of Senior Financial Officersresults were released last week, and more than three-quarters of mortgage bank members said they ‘Very likely’ to tap progress if their reserves fall below desired levels. Mortgage bank advances were the most preferred liquidity source included in the survey.
Zarling said there are several reasons banks tend to prefer prepayments, including that they are more expensive compared to other sources of funding, and that industry analysts, investors and peers use prepayments. There is no prejudice against things. On the other hand, looking to other institutions, such as the Fed’s discount window, tends to be viewed more negatively, he said.
Julie Hill, a University of Alabama law professor who specializes in financial regulation, said regulators were aware of their preference for advance payments and would need to approve their inclusion in banks’ liquidity plans. Stated. She said this was most likely the case between Silvergate and its main regulator, the Federal Reserve.
“Before FTX, the Federal Reserve was fully aware that cryptocurrencies pose their own liquidity risks, and Silvergate was fully aware of that as well.” and part of that plan is securities, and I would be very surprised if borrowing money from places like the Federal Mortgage Bank in San Francisco wasn’t part of its liquidity plan.”
Silvergate and the Federal Reserve Board declined to comment for this article.
Hill said he would have to argue that regulators did the right thing by letting Silvergate use the mortgage bank’s advances. On the one hand, she recognizes concerns that using advance payments to stem progress unnecessarily poses additional risk to the Federal Deposit Insurance Corporation’s deposit insurance fund.
The 11 federal mortgage banks were established by Act of Congress as government-sponsored corporations, but are privately capitalized by member banks, credit unions, savings banks, and other financial institutions. They enjoy certain benefits such as preferential taxation and financing costs. It also has a right of first lien, so if the bank fails, it will be repaid first. This means the FDIC may be on the brink of a potential bank failure in the future.
Zaring said this was a concern because the incentives for mortgage banks to support their members could conflict with broader financial stability considerations.
“The Fed is sitting [the Financial Security Oversight Council], mortgage banks do not, so the Federal Reserve has certain financial stability obligations that are important when thinking about bailing out banks in contagion and liquidity provision,” he said. I was. The board has such a systematic view of what is happening in the financial ecosystem. ”
In the case of Silvergate, Donovan said, as with all advancements, member bank regulators (in this case the Fed and FDIC) block the supply of liquidity if they feel the bank poses a threat to financial stability. said it may have.
“For things like Silvergate, the FDIC, Fed, and state banking regulators are in constant communication with mortgage banks,” he said. “If you have concerns about the safety and soundness of your bank, you can request that no advance payment be made.”
Hill said the episode shows how regulators themselves are taking a trial-and-error approach to managing the counterparty risk presented by cryptocurrency companies.
“Regulators are not allowing all banks or thousands of banks to do this,” Hill said. “Regulators have allowed a handful of banks to experiment in this area and may now be rethinking what kinds of experiments they will allow.”
Alison Hashmall, banking and regulatory attorney at law firm Debevoise & Plimpton, said she expects the Fed to take tougher action against banks seeking to do business with crypto companies. rice field.she pointed joint letter From the Fed, FDIC and Currency Commission issued earlier this month, regulators promised a prudent approach to overseeing digital asset exposures.
“[Regulators are] In pursuit of safe and sound practices, caution should be exercised and how much of the deposit base is of these types. [crypto] “Examiners want to look at it and make sure the bank isn’t overexposed. I don’t think they want to see that. [type of run] will happen again. “
Founded in 1988 as an industrial lending company, Silvergate started out as a commercial real estate specialist before transitioning to a single-family mortgage lender and then to a multifamily lender. In 2013, we started building our digital asset business. Today, most of the bank’s business is focused on providing payment, lending and financing services to cryptocurrency companies. Much of this is done through the Silvergate Exchange Network platform.
Meanwhile, Silvergate’s presence in the mortgage industry has declined. At the end of last year, we ended our mortgage warehouse loan product, citing rising interest rates and declining mortgages.
The fact that mortgage bank money is being used to support banks that have little activity in the mortgage sector has irritated some home advocates. With the Federal Housing Finance Agency, which oversees mortgage banks, undergoing a comprehensive overhaul of the system, some are calling for stricter rules to force banks to focus on their core mission. increase.
Caroline Nagy, senior policy adviser for housing, business power, and climate justice at Americans for Financial Reform, said that when mortgage banks subsidize banks, the government should ensure that their actions lead to the creation of more housing. said that it should be
“If we believe that facilitating liquidity for the nation’s largest banks and insurance companies is a good use of public resources, especially if we are talking about lien status and tax-exempt status of the system, we is really in the public interest,” Nagy said. “Frankly, we need the kind of investment that this banking system can generate. We desperately need affordable housing. We are in danger.”
The FHFA declined to comment for this article.
While some see Silvergate’s advances as an abuse of the mortgage banking system, Signature’s use of funding sources is more typical.
As one of New York’s largest multi-family lenders, Signature frequently uses New York’s mortgage banks to support its activities. It also launched a similar network for processing digital payments, but the drop in deposits — from $106.1 billion a year ago to $88.6 billion on Dec. The result. Exit the digital asset space.
“We are a prime example of how the Federal Home Loan Bank was set up because borrowing from the FHLB underpins lending in the multifamily sector,” said Eric R., Chief Operating Officer of Signature. Howell told American Banker“It’s really just part of the overall funding equation. We use these advances to fund our business.”
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