Where Debanking Didn't Happen

With no redactions

The 790 pages the FDIC released of its supervisory correspondence with banks regarding crypto activities have proven to be something of a Rorschach test. The debanking proselytizers see it as proof that the FDIC lied and had a concerted effort (“Operation Chokepoint 2.0”) to suffocate the crypto ecosystem by preventing access to the banking system. The other side, meanwhile, reads the letters simply as a prudential regulator asking material questions about risk management given genuine concerns about safety and soundness with respect to crypto-related activities.

As with any good Rorschach test, there are merits to both views, and FDIC inspector general report from October 2023 gets at the crux of why both views carry water: namely, crypto-related activities can be very risky for banks, but the FDIC has also lacked a clear policy for providing supervisory feedback in a timely manner. As the FDIC OIG wrote:

The FDIC issued letters (pause letters), between March 2022 and May 2023, to certain FDIC-supervised financial institutions asking them to pause, or not expand, planned or ongoing crypto-related activities, and provide additional information. However, the FDIC did not (1) establish an expected timeframe for reviewing information and responding to the supervised institutions that received pause letters, and (2) describe what constitutes the end of the review process for supervised institutions that received a pause letter.

Notably, the FDIC is the one in the scopes on this for its FIL-16-2022, but the OCC and Fed have essentially equivalent supervisory letters out—IL-1179 and SR 22-6, respectively. (Will Jonathan Gould and, say, Miki Bowman follow Travis Hill and release those agencies’ supervisory correspondence on crypto as well?)

While the debanking fire-and-brimstone crowd see the letters as a silver bullet in favor of their argument, that’s a hard sell. Any view on these letters requires some interpretation. So, rather than another article trying to read between the lines, I just wanted to mention some examples where we know supervisory debanking wasn’t happening. At the very least, this forces the debanking narrative to contend with some very public exceptions—particularly, for the largest banks.

For instance, while Coinbase’s Paul Grewal has effectively become the chief spokesman for the advocates of the debanking narrative, Coinbase has very publicly banked with JPMorgan—*checks notes* the largest and most reputable bank in America—for years. (Coinbase also has a stake in, and derives significant profits from, Circle and its USDC stablecoin, a company that is also a main player in this story—more on that below.)

March 2023

In the debate over debanking, those who contend it was all above-board supervising always have the checkmate move of pointing to Signature and Silvergate, which faced massive runs following the failure of FTX. Those were real safety and soundness risks that ex post justified the heightened supervisory scrutiny, if not the lack of the rigorous and timely process that the FDIC OIG noted.

But there’s two other things to note from the March 2023 episode.

1. Many of the debanking accusers like to remind the debate that the supervisory scrutiny wasn’t just over things like investing in crypto or lending against it, but about even disallowing crypto—and VC (after all, this debate started in earnest thanks to Marc Andreessen)—firms from accessing basic banking services like checking accounts and payroll.

   • Yet, the same officials allegedly implementing Operation Chokepoint 2.0 also invoked the FDIC’s “systemic risk exception” to ensure that SVB’s venture capital depositors and Signature’s crypto depositors did not get their deposits haircut. In making this determination, Fed and FDIC staff specifically were concerned about SVB’s and Signature’s failures disrupting their clients’ ability to make payroll—and contagion from their failures causing the same from similarly situated banks. As the GAO wrote (emphasis added):

     FDIC and the Federal Reserve reported observing that many of the uninsured depositors of the banks were corporate enterprises. Therefore, losses to these firms or an inability to access their funds for even a short time could put these firms at risk of not being able to make payroll and pay suppliers, potentially causing disruptions to U.S. market and industrial operations. The regulators cited examples of disruptions and losses. The Federal Reserve indicated that several depositors of SVB were unable to make payroll payments at the end of the week leading to the failure. In addition, several payroll companies contracted with SVB to process paychecks, which led to delayed payroll for companies that did not bank at SVB. The Federal Reserve also reported that some companies that held deposits at SVB were forced to sell their uninsured deposit claims at 90 cents on the dollar on March 10, 2023, to make payroll.

     While a large part of this decision process was clearly about contagion to other banks and the real economy, banking regulators made the decision to make these depositors whole—rather than draw a firebreak circle around SVB and Signature and just focus on stopping contagion. Or, better yet, they could’ve waited a little bit longer and—in addition to forcing losses on Signature’s crypto depositors and SVB’s VC depositors—could’ve let First Republic, PacWest, and Western Alliance melt down before creating the firebreak. Point being: the rescue actions lean against there being a strongly held political vendetta against these industries’ having checking/payroll accounts.

2. Circle’s USDC stablecoin briefly broke the buck as its industry-leading transparency¹ came back to bite. Here was a footnote from its February 2023 reserves examination report:

   

   Circle disclosed it had $3.3 billion stuck at SVB despite attempts to withdraw. USDC traded at less than 90 cents on the dollar that weekend — until the government announced it would stand behind the uninsured deposits of the failed banks, and it continued to loiter at a discount to until USDC announced it had cleared the backlog of redemptions:

   

In the week before the SVB failure, Circle had moved $5.4 billion to to BNY; by the Monday following the failure, had its ~$10 billion deposit pile exclusively at BNY (in addition to other invested assets):

Also as soon as Monday, Circle had two new banking partners for minting and burning stablecoins:

Taking a microscope to the March 2023 petri dish, you’d still need to squint to find a debanking story.

The Debanking Years Broadly

More generally, if press releases and headlines are any indications, big banks’ crypto projects marched on throughout the years that supervisors were allegedly choking off all things crypto-related.

Indeed, many of the released FDIC “pause letters” were asking banks questions about their proposed projects that involved internal blockchains or partnering with outside firms on crypto-technology projects. Yet, contra the debanking narrative that these questions were just a way for supervisors to infinitely play for time, the big banks (non-exhaustively):

• Decrypt, May 17, 2021:

  

• Decrypt, May 17, 2022:

  

• Wall Street Journal, August 22, 2022:

  

• New York Magazine, March 16, 2023:

  

• Bloomberg, May 9, 2023:

  

• Bloomberg, July 6, 2023:

  

• Bloomberg, September 18, 2023:

  

• Bloomberg, December 19, 2023:

  

  

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Big Banks Make Crypto Look Small

“Debanking” of the kind that’s currently in the zeitgeist seems to be particularly right-wing-coded. Ditto for a desire for regulatory and supervisory “tailoring.” Usually, that desire for tailoring is a desire to resist the (left-coded) urge to extend the regulatory/supervisory standards GSIBs down to midsized and small banks. Yet, appropriate “tailoring” of crypto banking risks probably means providing much greater scrutiny to midsize and small banks, for at least a couple reasons.

• New technology, with new money laundering risks, makes for huge fixed costs of compliance. GSIBs may already be there, or can get there with marginal costs. Small/midsize banks may need much further investment. E.g.: Silvergate’s internal real-time payments network, SEN, did not have functional automatic transactions monitoring for at least 15 months up to the FTX failure.

• The largest banks don’t need to take the risks of banking the margins of the cryptosphere to source their low-cost deposits. Banks like JPM and BofA already have huge franchises of offering 0% interest checking accounts, which customers accept on account of the convenience, other services, etc that these large banks offer. If you’re a smaller bank looking for a big pot of zero-interest deposits, offering to bank the crypto world looks like a pretty tempting way to do so. But the math assumes you can manage the franchise, avoiding the AML/KYC and financial stability risks. One way to read the supervisory letters is that they were asking banks to show their work on those fronts first, rather than the banks diving into the crypto industry and developing these management capabilities thereafter.

  • Crypto banking isn’t the only siren-song business model that suffers from this. SVB was also effectively paying nothing on its venture capital deposits; there’s certainly much less AML risk there, but the financial stability risk came home to roost. Maybe there’s a National Bank of Commercial Office Real Estate that will be next.

  If Circle fails, no one will worry about BNY’s stability. If Coinbase fails, JPM won’t be in more than one headline. These banks can take on these clients without crypto (or VC) becoming their new-and-unstable business model—and without making supervisors unduly nervous about their AML programs. The same can’t be said for smaller banks. As the January 2023 joint statement from the FDIC, OCC, and Fed said, “the agencies have significant safety and soundness concerns with business models that are concentrated in crypto-asset-related activities or have concentrated exposures to the crypto-asset sector.” That concentration would just hard to reach when you’re a bank with a massive balance sheet.

Distinctions between the underlying banks’ sizes may help explain the apparent discrepancy between the possibility of debanking in one interpretation of the pause letters and the many crypto-positive announcements of big banks.

Comments also welcome via email (steven.kelly@yale.edu) and Twitter (@StevenKelly49). View Without Warning in browser here.

1. Notably, Circle has since scrubbed its crisis-time press release and blogs from its website; see this Twitter thread.