The use of Federal Home Loan Bank advances to offset crypto deposit losses has raised questions about banks’ reliance on the quasi-governmental funding mechanism for liquidity.
La Jolla, Calif.-based Silvergate Bank and New York-based Signature Bank, arguably the two traditional banks with the greatest exposure to the digital asset industry, have both tapped Home Loan Bank advances following the collapse of the cryptocurrency exchange FTX.
Of the two, Silvergate, which has pivoted the bulk of its operations toward digital assets during the past decade, was more significantly impacted by the volatility in the wake of FTX’s demise. The bank received $4.3 billion in advances from the Federal Home Loan Bank of San Francisco in the fourth quarter of 2022 to offset $8.1 billion of drawn down deposits. Advances now account for more than 60 percent of Silvergate’s wholesale funding.
The episode puts a spotlight on both the supervision of crypto activity in the banking sector and the use of advances to support institutions that do little to support housing finance.
“The fact that this bank, which was exposed to steep crypto losses, was entangled with a Federal Home Loan Bank, that’s the first suggestion that the real financial system and crypto could be in some ways interconnected,” David Zaring, a legal studies professor at the University of Pennsylvania’s Wharton School of Business, said. “That it’s interconnected with … a pretty hidden avenue for banks to cover their liquidity needs is, in my view, a little worrisome.”
At the heart of the debate is whether the Federal Home Loan Bank of San Francisco, in providing advances to Silvergate, was merely sticking to its mandate to provide liquidity to a member bank, or if it was providing a de facto bailout to a firm engaged in a risky and unproven line of business.
Advances are intended to be a first-order liquidity source for member banks, said Ryan Donovan, president and CEO of the Council of Federal Home Loan Banks, an organization that serves as a voice for the entire Federal Home Loan Bank System. As long as a member is in good standing and can provide the proper assets as collateral, the Home Loan Banks are inclined to provide liquidity, Donovan said.
“Home Loan Banks aren’t an emergency source of liquidity. There’s this perception that if an institution has a need for liquidity they are in some way troubled, but liquidity issues could arise for a number of reasons in the normal course of business,” he said. “We were established by Congress to meet the needs of banks in those situations.”
Indeed, advances are often the first place many banks will turn for liquidity in a pinch. In the Fed’s latest senior financial officer survey, the results of which were published last week, more than three quarters of Home Loan Bank members said they would be “very likely” to tap advances should their reserves fall below their desired level. Home Loan Bank advances were by far the most preferred liquidity source included in the questionnaire.
There are several reasons why banks tend to favor advances, Zaring said, including their cost relative to other funding sources as well as the lack of stigma from industry analysts, investors and peers about using them. Meanwhile, turning to other facilities, such as the Fed’s discount window, tend to be viewed more negatively, he said.
Julie Hill, a law professor at the University of Alabama who specializes in financial regulation, said the regulators are aware of this preference for advances and would have to sign off on their inclusion in banks’ liquidity plans. She said this was most likely the case between Silvergate and its primary regulator, the Fed.
“The Federal Reserve absolutely knew before FTX that crypto presented unique liquidity risks, Silvergate absolutely knew that, too, that’s part of why their balance sheet looked so much different than a traditional community bank of a similar size,” Hill said. “You know Silvergate had a liquidity plan, you know part of that plan was securities and it would surprise me very much if borrowing money from places like the Federal Home Loan Bank of San Francisco wasn’t part of that liquidity plan.”
Silvergate and the Fed Board of Governors declined to comment for this article.
Hill said there is an argument to be made that regulators did the right thing by allowing Silvergate to fall back on Home Loan Bank advances because it enabled the bank to withstand the run and avoid failure. On the other hand, she sees the concerns that the use of advances to hold off a run is needlessly creating more risk for the Federal Deposit Insurance Corp.’s Deposit Insurance Fund.
The 11 Federal Home Loan Banks were created as government sponsored enterprises by an act of Congress, but they are privately capitalized by member banks, credit unions, thrifts and other financial institutions. They enjoy certain advantages, such as preferential tax treatment and fundraising costs. They are also given first lien priority, meaning they are repaid first in instances of bank insolvency. That means the FDIC could be on the hook for a potential future bank failure.
Zaring said this is concerning because the Home Loan Banks’ incentive to support their members could be in conflict with broader financial stability considerations.
“The Fed sits on [the Financial Security Oversight Council], Home Loan Banks do not, so the Fed has a sort of financial stability mandate that is important when you’re thinking about contagion and bank bailouts in provisions of liquidity,” he said. “It’s just not clear that the Federal Home Loan Bank Board has that kind of systemic view of what’s going on in the financial ecosystem.”
Donovan said in the case of Silvergate, as with all advances, the member bank’s regulators — in this case the Fed and FDIC — could have blocked the liquidity provision if it felt the bank presented a threat to financial stability.
“In the case of Silvergate and others, the FDIC, the Fed and state bank regulators are in constant contact with the Home Loan Banks,” he said. “If they had safety and soundness concerns about a bank, they could ask that the advance not be made.”
Hill said the episode demonstrates how the regulators themselves have been taking a trial and error approach to managing the counterparty risks presented by crypto firms.
“It’s not like regulators let all banks or thousands and thousands of them do this,” Hill said. “Regulators let a handful of banks experiment in this space and now they might be rethinking what sort of experimentation they’ll allow.”
Alison Hashmall, a banking and regulatory lawyer with the law firm Debevoise & Plimpton, said she expects the Fed to take a tougher tack with banks that seek to do business with crypto firms moving forward. She pointed to a joint letter from the Fed, FDIC and Comptroller of the Currency issued earlier this month, in which the regulators pledged to a cautious approach to supervising digital asset exposure.
“[Regulators are] advising banks that in order to pursue a safe and sound practice, you need to be mindful and consider how much of your deposit base is coming from these types of [crypto] companies,” she said. “Examiners are going to be looking at that and wanting banks to make sure they’re not over exposed. I don’t think they’d like to see that [type of run] happen again.”
Founded in 1988 as an industrial loan company, Silvergate began as a commercial real estate specialist before transitioning to a single-family mortgage lender and then a multifamily lender. In 2013, it began building its digital asset business. Today, the bulk of the bank’s business centers on providing payment, lending and funding services to crypto firms. Much of this is done through its Silvergate Exchange Network platform.
Meanwhile, Silvergate’s presence in the mortgage industry has dwindled. Late last year, it exited its mortgage warehouse lending product, citing rising interest rates and falling volumes of mortgages.
The fact that Home Loan Bank funds are being used to support banks that do little in the home finance space has frustrated some housing advocates. As the Federal Housing Finance Agency, which oversees the Home Loan Banks, conducts a comprehensive review of the system, some are calling for stricter provisions that will force the banks to focus on their core mandate.
Caroline Nagy, senior policy counsel for housing, corporate power and climate justice with Americans for Financial Reform, said if the Home Loan Banks are going to provide subsidized funding for banks, the government should ensure that activity is leading to the creation of more housing.
“If we think that promoting liquidity for the largest banks and insurers in the country is a valid use of public resources, and I’m talking specifically about the privileged lien status and the tax free status of the system, we really need to see a public benefit,” Nagy said. “Frankly, we have massive needs for the kind of investment that this banking system could produce. We desperately need affordable housing, we are in an affordable housing crisis.”
The FHFA declined to comment for this story.
Where Silvergate’s advances are seen by some as an abuse of the Home Loan Bank system, Signature’s use of the funding source is more typical.
One of the largest multifamily lenders in New York, Signature frequently taps the Home Loan Bank of New York for advances to support that activity, and took out $11.3 billion of advances in the fourth quarter of 2022. And while it has launched a similar network for digital payment processing, its falling deposits — which were $88.6 billion on Dec. 31, from $106.1 billion a year earlier — are the result of conscious effort to pull back from the digital asset space.
“We are truly the quintessential example of what the Federal Home Loan bank was put in place for because any borrowings that we do have from the FHLB are supporting our lending in the multifamily sector,” Eric R. Howell, Signature’s chief operating officer, told American Banker. “It’s really just part of our overall funding equation. We use these advances to fund our businesses.”