10 Lessons Learned from Recent Bank Failures

We are in the midst of a crisis of trust in our banking system, with many parallels to the great financial crisis of 2008. Crypto did not exist during the last financial crisis, and it has nothing to with our current one. The first cryptocurrency – Bitcoin – was actually born out of the 2008 crisis by an unknown person or group of persons, known as Satoshi Nakamoto. The revolutionary concept in the original Bitcoin white paper and subsequent blockchain resulted in a system that allows for peer-to-peer transactions without needing trusted third parties, specifically eliminating the need for traditional financial intermediaries. Flash forward 15 years: we’re again faced with another financial crisis and the critical need to understand what happened and why.  After 2008, policymakers around the world responded with a comprehensive re-assessment of the regulations around the financial sector.  With the current circumstances, a re-assessment may well be order, but it should be coupled with a willingness to look at the opportunities that new innovations – particularly in crypto and digital assets – provide in enhancing the current system, enhancing transparency and reliability, reducing costs and – critically – empowering individuals to have more control and choices in their financial lives. 

In order to do that, it’s important to begin with understanding the lessons learned over the last two weeks. 

1. Crypto did not cause the failures of Silicon Valley Bank (SVB) or Signature Bank, or cause the broader instability in our banking system that has followed. Although each bank failed for slightly different reasons, the common thread is they all had a high concentration of uninsured deposits covered by a mix of longdated Treasury bonds and mortgage backed securities purchased at a time when interest rates were historically low. When the Federal Reserve Board (“Fed” or “FRB”) increased the interest faster than it had in more than 40 years, it created a mismatch in liabilities and assets. 

Regulators have known about banks’ asset and liability mismatches for years, but have provided inconsistent guidance and supervisory oversight. In Spring 2022, the OCC identified the risk, noting significant uncertainty about depositor behavior if short-term market rates begin to increase and highlighting that banks should both model various interest rate risk and liquidity scenarios and revisit contingency funding plans and sources for unanticipated deposit runoffs. In contrast, the Fed’s fall 2022 supervisory outlook for regional banks did not mention liquidity or interest rate risk. In the same inconsistent manner, the spring 2022 supervisory outlook said that regional banks’ cash positions had reduced liquidity risk. 

This was most acute in the case of SVB. SVB more than doubled in size in less than 18 months. That extreme growth should have been coupled with increasing oversight from regulators. SVB had “minimal exposure” to crypto, but heavy exposure to the technology, biotech, and venture capital sectors – highly cyclical industries that are themselves especially sensitive to interest rate increases. As discussed below, that customer concentration amplified the effect of interest rate hikes. Contrary to popular rhetoric, the Federal Reserve had complete authority to direct SVB to address imbalances in its balance sheet and its client mix. Among other actions, the FRB could have applied rules implemented in 2021 under the Basel Accords, known as Basel III that would have required banks like SVB to satisfy the liquidity requirements of larger banks. And they should have. 

Signature Bank was more diversified than SVB, which resulted in slower growth and less pressure on their balance sheet from rapid withdrawals from technology companies and mismatched assets and liability. But, as the New York Department of Financial Services said, their decision “was based on the current status of the bank and its ability to do business in a safe and sound manner on Monday.” NYDFS also noted, “The decisions made over the weekend had nothing to do with crypto. Signature was a traditional commercial bank with a wide range of activities and customers.” This points to larger concerns related to the management of the bank and their ability to meet customer demands and manage risk.

2. Banks need diversity in depositors and clients, just like businesses need diversity in banking partners. Silicon Valley Bank (SVB) and Silvergate had a narrow customer base that created concentration risk. That concentration risk left them susceptible to downturns in specific industry sectors. In both cases, the banks suffered because their customers suffered from macroeconomic conditions that created bear markets in the technology industry. The banking outcome was avoidable. A bedrock concept of risk management is diversification of exposure. History provides a guide to why: interstate branching was born when it became apparent that restricting geographic diversity left banks vulnerable to a local economic crisis, such as the local plant closing or the failure of a season’s crop. By allowing banks to diversify their customer base, they were safer and sounder. In the same way today, allowing more banks to serve crypto clients would help banks unlock new funding sources, while also ensuring that legitimate and legal crypto companies have redundancies that help protect their workers and their customers. 

3. Silvergate was one of the few banks embracing crypto innovation, which led to innovation but also contributed to risky concentration. While concentration can bring risk that needs to be managed, it can also allow a bank to develop special services and expertise for particular industries. This healthy specialization, however, is far different than the abandonment of basic risk management and diligence obligations that banks have. With regard to Silvergate, its risk management seemingly failed to catch alleged criminal behavior and basic governance failures that arose with FTX.com, FTX.US, and Alameda Research. The relationship between FTX and Alameda should have raised flags at the bank, and it’s hard to see how that was allowed to happen. That is on Silvergate. But regulators also played a role in Silvergate’s failure because they either unknowingly or carelessly increased the concentration of crypto in Silvergate by discouraging other bank’s involvement in crypto. They then contributed to a run on Silvergate as a result of some are speculating were politically motivated statements and assertions that crypto was too risky to bank, meaning that banks who allowed digital asset participants to have bank services were operating under a supervisory cloud, and clear negative signal for any assessment of a bank’s standing. Silvergate was the bank of choice for many crypto companies because they offered innovative 24/7 payment and settling solutions and worked hard to understand the business of crypto. The regulators put significant pressure on Silvergate by suddenly expressing their disfavor of one of their largest depositor bases. 

 4. Banking policy should be free of discrimination against specific industries like crypto, which creates an uneven distribution of risks. Since January 2023, financial and market regulators have appeared to engage in an increasingly coordinated effort to limit access to banking services by crypto companies. In January, the Federal Reserve (“Fed”), Federal Deposit Insurance Corporation (“FDIC”), and Office of the Comptroller of the Currency (“OCC”) issued a joint statement – not a rule – discouraging banks from owning crypto assets on public blockchains. Later that month, the Fed also issued a final rule – without notice and comment – that effectively prohibited a large portion of cryptocurrency banking activity. And finally, in February, the Fed, FDIC, and OCC again acted together to emphasize the liquidity risks to banking organizations associated with certain sources of funding from crypto-asset-related entities. The collective guidance has resulted in banks of all sizes wondering about the legal and regulatory lines for banking crypto. This uncertainty has been tested over the recent week as banks have been flooded with all types of companies who need banking services. High tech companies are cyclical and they always have been - just like agriculture, energy, and many other industries. Crypto is no different and does not present any new or unreasonable risk factors. Imagine if banks refused to serve companies that specialize in artificial intelligence or bioscience, or refused to serve farmers because sometimes they might face a drought. 

5. Rather than prohibit safe crypto activities, regulators should encourage effective risk management. Every industry has particular risk characteristics, and traditional risk management principles typically work well to address any risk. This is as true for crypto as it is for any other sector. The bank regulators, however, seem to treat crypto as uniquely impervious to traditional risk management. The Basel Committee, on which bank regulators sit, actually proposed that banks must hold 100% capital against every crypto position, even though these days crypto is no more volatile than mid-cap tech stocks. This abandonment of traditional risk management principles stunts the development of risk management practices that are needed for any sector, and perhaps more for technology and industry that is growing rapidly around the world as consumers, and now governments, embrace it. 

6. Regulatory policy decisions should be made in the daylight with proper rulemaking, not in closed door meetings that lead to conflicting statements and inconsistent supervision. At Coinbase, we strongly support robust risk and liquidity management and work tirelessly with our banking partners to meet all of our legal and regulatory obligations, but we are concerned about regulators pushing crypto out of both the regulatory perimeter and the banking system. Limiting access to banking services won’t make the banking system or the crypto markets safer. It will simply push activity into the shadows and overseas. We would urge regulators – including market regulators – to engage in proper rulemaking that would decrease uncertainty in the market and thereby reduce risk for companies and their banking partners. 

7. The world still relies on the U.S. dollar, and crypto makes it stronger. The recent move by the Federal Reserve along with five additional central banks to increase the availability of U.S. dollar swap lines underscores the position of the U.S. dollar as the world’s reserve currency. The adoption of crypto also reinforces that. Around 95 percent of all crypto trades are conducted using dollar-denominated stablecoins. This is important because that means funds are flowing into the U.S. financial system not out of the system. Other countries understand this dynamic and are moving rapidly to create non-U.S. dollar crypto alternatives. The EU, for example, recently passed a comprehensive crypto regulatory regime that limits the ability of non-Euro denominated stablecoins to operate in the EU. Although not explicitly articulated, it appears an important motivation was the hope of incubating an alternative to US dollar-denominated stablecoins. While the EU has moved first, other countries are considering similar measures aimed at weakening the link between the crypto markets and the U.S. dollar.

8. Crypto can help make the financial system better, faster, cheaper.  The existing financial system has been one of the most important contributions to developing the global economy, and allocating capital more effectively and efficiently.  Yet, our current system is largely unchanged over many decades. This is not just an academic observation – 80% of Americans say the system needs an update and 67% say it is seriously broken. The events of the last two weeks underscore this important point.  The financial system does not work for all Americans today and it needs an upgrade.  Crypto and blockchain technology can improve the system by, among other things, reducing counterparty risk, eliminating costly intermediaries, and settling instantly.  The technology is powerful and should be leveraged to make our existing systems work better.  Much like the move toward electronic trading in the late 1960s, which was hugely disruptive to incumbents and markets, it ushered in the explosive growth of our capital markets and helped fuel significant elements of economic growth in the decades that followed.  The willingness to make that jump was critical to the rapid growth of our financial system, and to New York (and London) remaining the centers of global finance.  The disintermediating impact of crypto technologies will be similarly disruptive, as the evolution of our financial system and our economic lives are becoming more closely related to the technical advances of the internet.  Crypto is the next internet and policymakers should ensure it’s built in the U.S. to maintain our competitive edge.

9. Systemic risk doesn't happen overnight.  Crypto is not a systemic risk today, but it is and will remain an increasing sector in our economy.  Regulators need to work together to develop a comprehensive regulatory framework that puts in place an effective market structure for the buying, selling, and trading of crypto assets.  This is important to the health of the banking system because it will stabilize crypto markets and build confidence in the underlying value of the technology, which is transformational.  Market regulators like the SEC have a critical role to play and could help improve the safety and soundness of the entire ecosystem by engaging in public rulemaking.  

10. Crypto is a $1 trillion industry and the rest of the world is moving to regulate it. The rest of the world knows the power of crypto and is embracing it. They are creating robust regulatory frameworks that create certainty for the ecosystem, while providing the stability critical to maintain a strong banking and financial system. Jurisdictions like the European Union, Hong Kong, Singapore, and Australia are adopting new rules that recognize the unique characteristics of crypto and blockchain technology. For example, in Singapore and Japan, regulators worked with JP Morgan to allow the use of DeFi in foreign exchange transactions.  In the EU, regulators are similarly providing “sandboxes” for financial institutions to experiment with the adoption of tokenization and new technology.  That same willingness to allow for innovation should be an imperative for US policymakers with regard to the US capital markets and banking system.