FTX’s banking ties raise uncomfortable questions for regulators

(Bloomberg) – The remnant of Sam Bankman-Fried’s crypto empire lays bare the industry’s growing entrenchment in the traditional banking system.

While there’s no indication that FTX’s dramatic collapse poses systemic risk, its bankruptcy filings read like a warning label about what could go wrong. The revelations also raise a pressing question for US regulators and lenders: Are they doing enough to keep tabs on the growing sector?

For months, federal watchdogs have been warning banks to be cautious with digital assets, and for the most part, Wall Street has heeded that call. Some small US lenders have eagerly courted crypto firms, including those based overseas.

“How is the US government protecting US consumers from a Bahamas-based crypto exchange?” said Kevin Carr, a financial industry consultant and former Treasury Department official, referring to FTX. “There is no easy answer to this, but it underscores the issue of jurisdictional shopping where a business will choose to locate in a country with less stringent oversight.”

FTX listed in bankruptcy filings Silvergate Capital Corp. and Signature Bank, both of which are federally regulated by the United States, as places where it or related entities had accounts. He also highlighted Bahamas-based Deltec Bank & Trust, which is not directly supervised by Washington but is well known in the crypto world.

The three institutions sought to explain that their exposure to the turmoil was limited.

Silvergate said FTX-linked deposits accounted for less than 10% of the $11.9 billion held for digital asset clients as of September 30. Signature cited an even lower percentage — of less than 0.1% of its overall deposits as of Nov. 14 — and said its deposit base has remained flat since the stock market collapse. Meanwhile, Deltec said on its website that it has “no credit or asset exposure to FTX.”

Deposit accounts

The links, however, extend beyond filing accounts, bankruptcy filings show. They pointed to a surprising development that a venture capital fund tied to Bankman-Fried’s Alameda Research hedge fund invested $11.5 million in Farmington State Bank, which does business as Moonstone Bank in the United States. State of Washington.

Moonstone said in a statement Tuesday that it received the investment from Alameda in January as part of a capital raise, when the company “had an immaculate reputation and was the darling of the financial markets.” The share represents less than 10% of Moonstone, he said.

“Alameda has a non-controlling interest in Moonstone, with no board member and no involvement with management,” he said. The bank, which transformed its business model following its 2020 acquisition by FBH Corp., said it has remained in close communication with regulators and added controls “to ensure that all of our activities comply with all applicable laws and regulations”.

The Washington State Department of Financial Institutions said the investment did not require regulatory approval because it did not constitute a majority stake in the company.

It’s not just smaller banks or regional lenders that have sought to capture crypto business. Some of Wall Street’s biggest firms have started offering crypto services, including trading, wealth management, and advice, which are generally less risky to their businesses than accepting crypto deposits or investments.

Bank of New York Mellon Corp. launched a U.S. digital asset platform in October allowing select customers to hold and transfer Bitcoin and Ether, which it says is the first from a global bank to provide such services.

In comments that now seem prescient, Fed Vice Chairman Michael Barr said in October that banks should be careful about partnering with crypto firms, given the interdependence between asset companies. digital exposed by recent market failures. Barr also warned that working with crypto companies can expose banks to risks such as fraud, theft, manipulation and money laundering.

Neither federal nor state regulators have accused Silvergate, Signature, Deltec or Farmington State Bank of wrongdoing in their dealings with FTX.

Representatives of the Federal Reserve, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency all declined to comment on whether FTX’s filings highlight regulatory blind spots.

“Reckless” Risks

On Wednesday, Sherrod Brown, head of the Senate Banking Committee, urged U.S. Treasury Secretary Janet Yellen to work with lawmakers to craft crypto legislation that addresses the risks exposed by FTX’s collapse.

“As we continue to learn more details, the failure of this crypto exchange recalls the litany of financial firm bankruptcies due to the combination of reckless risk-taking and misconduct,” said Brown, a Democrat from Ohio, in a letter to Yellen. . “Congress and financial regulators need to work to get this all right.”

Yellen, for his part, told a New York Times event on Wednesday that the FTX debacle was “the Lehman moment within crypto,” referring to the collapse of investment banking giant Lehman. Brothers Holdings Inc. in 2008 that crippled global credit markets.

“We have always urged that regulatory loopholes be closed,” Yellen said. “This experience with his company, or set of companies, could not provide a better illustration. These are very risky assets, but the bright side of a boom like the one we’ve seen is that it didn’t spread to the banking sector.

FTX magnification

Certainly, even before the FTX explosion, federal regulators were mulling over how to handle crypto ties to traditional finance.

Throughout 2022, the FDIC has tried to crack down on companies, including FTX and Voyager Digital LLC, over allegations that they may mislead investors into believing their money is covered by insurance. deposits. Both companies are now bankrupt.

In the case of Voyager, the crypto platform has stated in some documents that US dollar deposits with the company are covered by FDIC insurance, should the crypto company or the bank default. In reality, while Voyager’s banking partner, Metropolitan Bank Holding Corp., was insured, Voyager was not, meaning customers would not benefit from insurance if Voyager went bankrupt.

Meanwhile, banks and the trade groups that represent them have said they lack clarity from Washington regulators on how to engage in crypto business, including through partnerships with companies. digital assets and fintechs.

Auto control

Sultan Meghji, the FDIC’s former director of innovation, acknowledged banking regulators struggled to manage such partnerships and said watchdogs could do “much more.”

In the meantime, however, Meghji said he expects banks offering services to crypto companies to come under much more scrutiny after the failure of FTX. He said companies should consider doing more self-policing so they are not held liable for any wrongdoing.

“I would do a full audit of all my banking clients as a service and review the beneficial ownership of all those clients to make sure I haven’t – knowingly or unknowingly – slept with the next FTX,” Meghji said. .

(Updates with Sherrod Brown, comments by Janet Yellen after the “Reckless” Risks subtitle.)

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