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This article examines the recent U.S. bank failures and the risk of cryptocurrency assets at insured depository institutions.
IN EARLY MARCH 2023, THREE U.S. BANKING INSTITUTIONS failed, resulting in increased focus on supervision and regulation by the Board of Governors of the Federal Reserve System (Federal Reserve Board), the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) (collectively, the federal banking agencies). The article will provide an overview of applicable laws, examine the FDIC role in a bank failure, and explore federal guidance on the management of risk related to crypto-assets.
Banks collaborate with financial technology (fintech) and other companies to provide traditional banking services. Such collaboration is found in the areas of commercial banking, online marketplace lending, open banking services, capital markets, trade finance, real estate transactions, venture capital investments, sponsorship of programs, and other areas closely related to banking. Fintech companies are also altering the bank payments landscape by replacing legacy bank payment systems with technologies such as mobile wallets, digital currency, and cryptocurrency transactions.
Fintech companies are subject to regulation by the federal banking agencies, insomuch as they partner with, or provide third-party services to, regulated financial institutions.
In November 2022, a historic event occurred as FTX Corp., a top transactional exchange platform used to buy and sell cryptocurrency, collapsed, and filed for bankruptcy. The collapse triggered a level of financial instability that is yet to be realized, as customers attempted to cash out billions of dollars in deposits and venture capital firms suffered major losses and write-offs of debt. FTX Corp. did not maintain adequate reserves against customer deposits and was unable to cover trades executed on the platform. Subsequently, the Securities Exchange Commission (SEC) charged Samuel Bankman-Fried, the CEO and co-founder of the cryptocurrency trading platform FTX, with orchestrating a scheme to defraud FTX investors using an affiliated entity, Alameda Research Fund.1
Another notable cryptocurrency crash occurring in 2022 involved Terraform Labs PTE Ltd. (Terraform), a blockchain platform offering stablecoins LUNA and TerraUSD. These algorithmic stablecoins, pegged to the U.S. dollar, crashed after deposits dropped, investors withdrew funding, and the stablecoin’s value plummeted to $0.30. Stablecoins can be collaterized (backed by U.S. dollar denominated assets or crypto-assets such as tokens), or uncollateralized (not backed by any external assets). The SEC charged Terraform and its principal, Do Kwon, with securities fraud involving stablecoin and other crypto-asset securities.
Volatile markets and broad swings in pricing also resulted in exchange platforms Blockfi, Voyager Digital, and Celsius Network experiencing liquidity issues and later filing for bankruptcy. The events associated with cryptocurrency in 2022 followed a period of high growth and financial gains for many institutions. The bankruptcy and other civil cases arising out of these events highlight that the instability and collapse of crypto-asset-related institutions such as FTX and Terraforms transcend the online digital market to affect many other forms of financial services.
Between 2020 and 2023, six banks have closed or received assistance from the FDIC:
* Data obtained from FDIC BankFind Suite
** Depository Insurance Fund (DIF)
In March 2023, Silvergate Bank decided to wind down its operations and voluntarily liquidate, and two other banks, Signature Bank and Silicon Valley Bank, were placed into receivership with the FDIC. Several other banking institutions continue to experience liquidity concerns:
While the impact of the crypto-exchange collapse on banking institutions unfolds, the proximate cause of the bank fallout from crypto-assets has yet to be determined.
Current Risk, Economic, Regulatory, and Financial Conditions
There is no single cause that points to the FTX or Terraform cryptocurrency collapses. Common to their demise are a concurrence of control failures including overextension, inadequate or no risk management framework, and fraudulent activity. Such is not an isolated case, as the same common control failures are seen as the precondition to current bank failures. The current environment for financial services risk—economic, regulatory, and financial conditions in the United States—may also have a causal effect on bank failures:
The Financial Stability Oversight Council (FSOC), established by the Dodd-Frank Act to identify risks and respond to emerging threats to the financial stability of the United States among other functions, issued the Report on Digital Asset Financial Stability Risks and Regulation (October 3, 2022),5 noting that crypto-asset activities contributed to instability within the crypto-asset ecosystem. The primary risks from crypto-assets were a result of:
The federal banking agencies have regulation, supervision, examination, investigation, and enforcement authority of banking activity at the federal level. Other federal and state agencies are also empowered with certain responsibilities to support the stability and viability of the U.S. financial system. Federal laws and regulations are in place to safeguard FDIC-insured banks from the risks associated with deposits sourced from crypto-assets. Following is a discussion of the key laws in place to safeguard FDIC-insured banks. This listing is not all inclusive.
The Dodd-Frank Act was enacted following the financial crisis of 2008 and is intended to address systemic risks of systemically important financial institutions (SIFIs). SIFIs are subject to the Dodd-Frank Act’s enhanced prudential standards (EPS), which include among other areas, heightened supervision and examination by the Federal Reserve System, increased regulation, and increased regulatory reporting. While EPS requires larger capital requirements of SIFIs, small to mid-sized banks (with total consolidated assets of $100 billion but less than $250 billion) are not subject to EPS requirements.
The Dodd-Frank Act also included the Volcker Rule,6 which prohibits lenders from engaging in certain hedge fund or private equity firm proprietary trades or investments, thereby reducing potentially risky investments by lenders. FDIC-insured depository institutions, U.S. bank holding companies, and affiliated institutions and nonbank financial companies supervised by the Federal Reserve Board are subject to the prohibitions under the Volcker Rule.
Economic Growth, Regulatory Relief, and Consumer Protection Act
The Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA)7 was passed on May 24, 2018. The EGRRCPA amended certain regulations implementing the Dodd-Frank Act, among which were creating exemptions from the U.S. Basel III-based capital requirements for smaller banking institutions, reducing EPS to the largest U.S. bank holding companies or SIFIs, and amending the Volcker Rule to exempt institutions with less than $10 billion in total consolidated assets from its proprietary trading prohibitions.
FDIC Insures Depository Institutions and Systemic Risk Exception
The FDIC is a federal banking agency with authority and responsibility8 to:
The net amount due to any depositor at an IDI is an aggregate of deposits in all accounts of the institution and shall not exceed the standard maximum deposit insurance amount.9 The standard maximum deposit insurance amount is currently $250,000.
FDIC insurance extends to IDIs. At the onset of a liquidity crisis, crypto-asset entities are unable to seek a bailout from the federal government under the programs in place for insured deposits and investments.
Bank runs and bank failures may result in serious instability to the U.S. banking system. To address the immediate liquidity needs of a bank and forestall potential systemic disruptions, a systemic risk exception may be granted. A systemic risk exception is permissible if the failure of an institution under FDIC receivership would have serious adverse effects on economic conditions or financial stability, and action or assistance from the FDIC would avoid or mitigate such adverse effects.10 On March 12, 2023, Secretary of the Treasury Janet Yellen, in a joint statement with the Federal Reserve Board and FDIC,11 made a systemic risk exception for Silicon Valley Bank and Signature Bank, allowing the FDIC to cover all of the institutions' depositors for more than the insured portion of deposits (currently $250,000). While depositors will have access to all of their deposits, the exception does not extend to shareholders and certain unsecured debtholders.
Further, the Federal Reserve Board made additional funding available to eligible depository institutions. This new Bank Term Funding Program (BTFP)12 offers loans secured by qualified collateral to banks, savings associations, credit unions, and other eligible depository institutions. BTFP loans are available through the Federal Reserve Board Discount Window.
Crypto-Asset Entities' Federal Regulation, Supervision, and Examination
Nonbank crypto-asset entities are not directly regulated, supervised, or examined by the federal banking agencies. A special-purpose national bank charter, known also as the fintech charter offered by the Office of Comptroller of the Currency (OCC) for nonbank technology firms, a trust charter, or a bank partnership with fintechs, are ways in which nonbank crypto-asset entities would be brought into the scope of federal banking agencies’ supervision, regulation, and enforcement. State laws and regulations also govern the activities of nonbank crypto-asset entities, requiring state licensing where the entity engages in cryptocurrency or other virtual currency activities in order to protect consumers, safeguard customer funds through cybersecurity rules, prevent money laundering, and root out illicit activity.
The federal banking agencies, the Consumer Financial Protection Bureau, an independent agency of the Federal Reserve Board established under the Dodd-Frank Act, and the U.S. Department of Treasury Financial Crime Enforcement Network (FinCEN), each have statutory authority to supervise entities that contract or partner with regulated financial institutions. A crypto-asset entity providing material services to a bank in connection with a financial service or product is subject to regulatory oversight. The federal banking agencies and FinCEN have issued regulatory guidance requiring the crypto-asset entity to:
While fintech firms focus on a range of activities, products, and services that complement traditional banking activities, crypto-asset entities are not themselves banks, and the entities’ deposits are not insured by the FDIC. Crypto-assets are prohibited from advertising deposits as insured or holding themselves out as regulated entities.
“Section 18(a)(4) of the Federal Deposit Insurance Act (‘FDI Act’), 12 U.S.C. § 1828(a)(4), prohibits any person from representing or implying that an uninsured deposit is insured or from knowingly misrepresenting the extent and manner in which a deposit liability, obligation, certificate, or share is insured under the FDI Act.”13 The FDIC is charged with enforcing this provision.
Regulatory Response to Bank Failures
Following the Silicon Valley Bank and Signature Bank failures, the U.S. Department of Treasury, the FDIC, and President Joseph R. Biden immediately addressed the public, seeking to promote trust in the U.S. banking system, restore consumer confidence, and curb additional bank runs. Additionally, federal banking agencies have called for tightened scrutiny of crypto-assets and increased scrutiny of banks’ credit, interest, and liquidity risk management practices.
The U.S. Department of Justice and the SEC opened investigations into the collapse of Silicon Valley Bank. Key congressional committees have begun hearings on the cause of bank failures and regulatory response.
Analysis of the impact cryptocurrency may have played in recent bank failures is ongoing. A review of the financial services of Silvergate, Silicon Valley, and Signature Bank confirms a range of commercial banking, commercial and residential real estate lending, and deposit taking activity. The institutions also partnered with and provided specialized commercial banking products and services to emerging fintech companies throughout the United States.
Treasury Secretary Yellen, speaking at the U.S. Senate Banking Committee hearing on March 16, 2023, did not confirm a financial crisis for the U.S. financial system or that the risk from crypto-assets was the primary cause of the bank failures. Yellen acknowledged that Silicon Valley Bank’s high reliance on uninsured deposits coupled with a massive bank run on deposits caused a liquidity crisis for the institution. Such would be the case for even the strongest bank. Yellen reaffirmed that the U.S. banking system remains strong and deposits safe.
The FSOC 2022 Annual Report14 includes an assessment and recommendations to address the financial stability risks of digital assets. The FSOC 2022 Annual Report indicated that while the risks associated with digital assets were increasing for banking institutions transacting in crypto-assets, the instability in the crypto-asset ecosystem did not result in notable effects on the stability of the traditional financial system. The FSOC recommended the following actions to address identified regulatory gaps in the regulation of digital assets:
On February 23, 2023, the federal banking agencies issued an interagency statement on the liquidity risks presented by certain sources of funding.15 The banking agencies highlighted increased liquidity risks arising from crypto-deposits, particularly where the client is a cryptocurrency exchange, stablecoin issuer, financial technology company, or other crypto-related institutions.
According to the interagency statement, liquidity risk for crypto-assets is heightened due to various factors, including the unpredictability of the scale and timing of crypto-asset deposit inflows and outflows, unanticipated redemptions, dislocations in crypto-asset markets, noted periods of stress, market volatility, and other related vulnerabilities in the crypto-asset sector.
Regulators, while calling for more stringent regulation around crypto-assets, are pointing to existing federal guidance on effective risk management practices. Banks and other institutions providing banking services are expected to have a risk-based risk management program to properly identify, measure, monitor, and control funding and liquidity risk. Additionally, the risk management program must include procedures and appropriate strategies covering:
The guidance emphasizes the importance of certain processes for sound liquidity and funding risk monitoring and management, including cash-flow projections; diversified funding sources; a cushion of liquid unencumbered assets; and a well-developed, documented and board-reviewed contingency funding plan. The interagency statement supplements existing guidance on funding and liquidity risk management, which remains in effect.
In an effort to promote global liquidity risk management principles to ensure the safety and soundness of financial institutions, the Basel Committee has published the Prudential Treatment of Cryptoasset Exposures (Cryptoasset Prudential Standard).16 Crypto-asset is defined as “private digital assets that depend on cryptography and distributed ledger technologies (DLT) or similar technologies. Digital assets are a digital representation of value, which can be used for payment or investment purposes or to access a good or services.”17 Crypto-asset does not include central bank digital currencies within the Cryptoasset Prudential Framework. This Cryptoasset Prudential Standard, agreed to by members of the Basel Committee, establishes the following risk standards for crypto-asset exposures:
The implementation date for the Cryptoasset Prudential Standard is January 1, 2025. Bank for International Settlements plans to closely monitor the implementation and effects of the Cryptoasset Prudential Standard through Basel III-required data and regulatory reporting. For more information on the Classification of Crypto-assets, Redemption Risk Test and Supervision/Regulation Requirement, follow this link to read the full practice note.
Minimum Capital Requirements
Federal banking regulators require banks to maintain a level of regulatory capital based on the risk profile and complexity of their operations. Banks may be required to maintain higher regulatory capital at the discretion of the supervising federal banking regulator. The federal banking agencies’ prompt corrective action authority enforces capital adequacy standards.
Under Basel III capital rules, SIFIs must maintain sufficient capital to satisfy minimum risk-weighted and leverage capital ratios. The leverage ratio buffers apply to global systemically important banks and serve to complement the risk-weighted capital requirements by providing, among other things, a safeguard against unsustainable levels of leverage.
Supervisory Review ProcessThe Cryptoasset Prudential Standard provides for a supervisory review process for banks’ exposures to crypto-assets. It establishes responsibilities for banks to establish a comprehensive risk management framework that includes policies, procedures, and controls (informed by existing Basel Committee statements) to identify, assess, and mitigate the following risks on an ongoing basis:
Bank supervisors’ responsibilities include reviewing a bank’s policies and procedures for appropriateness and identifying and assessing the crypto-asset risks and the adequacy of their assessment results. Supervisory actions, in cases where crypto-asset risks are not sufficiently covered, may vary based on supervisory authority and may involve a supervisor requiring the banks to address any deficiencies in their identification or assessment process of crypto-asset risks, making additional stress testing or scenario analysis recommendations, or imposing additional charges or other provisioning to cover potential or foreseeable losses.
Celeste Mitchell-Byars is the Content Manager for the Lexis Practical Guidance Financial Services Regulation Practice Area. Prior to joining LexisNexis, she served as Counsel, Chief Compliance Officer for Deutsche Bank AG, Regulex Corp, MUFG, Dexia S.A., and as Regulatory Advisory Services Manager at PriceWaterhouseCoopers.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Financial Services Regulation > Trends & Insights > Practice Notes
For a list of key practice notes, templates, and checklists covering major financial services regulation issues and tasks, see
> FINANCIAL SERVICES REGULATIONS FUNDAMENTALS RESOURCE KIT
> BANK FAILURE RESOURCE KIT
> OCC FINTECH CHARTER RESOURCE KIT
> VIRTUAL CURRENCY, BITCOIN, AND CRYPTOCURRENCY RESOURCE KIT
> CRYPTOCURRENCY REGULATION OVERVIEW VIDEO
> CRYPTOCURRENCY LITIGATION AND REGULATORY PROCEEDINGS TRACKER
> FEDERAL BANKING REGULATORY AGENCIES EXAMINATION AND ENFORCEMENT AUTHORITY
For a discussion of the prohibitions directed at banking entities under the Volcker Rule, contained within the Dodd-Frank Act, see
> VOLCKER RULE
For an analysis of the resolution plan requirements for financial and insured depository institutions, see
> DODD-FRANK ACT AND INSURED DEPOSITORY INSTITUTION RULES RESOLUTION PLANS (LIVING WILLS)
> SYSTEMIC RISK REGULATION OF SYSTEMICALLY IMPORTANT FINANCIAL INSTITUTIONS
For an explanation of the FDIC’s responsibilities in the event there is a failure of an insured depository institution, see
> FEDERAL DEPOSIT INSURANCE CORPORATION’S ROLE AFTER FAILURE OF AN INSURED DEPOSITORY INSTITUTION
For an overview of the legislative and regulatory treatment of virtual currency in all 50 states and the District of Columbia, see
> VIRTUAL CURRENCY STATE LAW SURVEY
1. S.E.C. v. Samuel Bankman-Fried, No. 1:22-cv-10501, 2023 SEC LEXIS 143 (S.D.N.Y. filed Dec. 13, 2022). 2. U.S. Department of the Treasury, Joint Statement by the Department of the Treasury, Federal Reserve, FDIC and OCC (Mar. 16, 2023). 3. Federal Reserve Board, Statement by Secretary of the Treasury Janet L. Yellen and Federal Reserve Board Chair Jerome H. Powell (Mar. 19, 2023). 4. Pub. L. No. 111-203, 124 Stat. 1376 (July 21, 2010). 5. https://home.treasury.gov/system/files/261/FSOC-Digital-Assets-Report-2022.pdf. 6. 12 U.S.C.S. § 1851. 7. Pub. L. No. 115-174, 132 Stat. 1296 (May 24, 2018). 8. 12 U.S.C.S. §§ 1811 through 1835a. 9. 12 U.S.C.S. § 1821. 10. 12 U.S.C.S. § 1823 (c)(4)(G). 11. U.S. Department of the Treasury, Joint Statement by the Department of the Treasury, Federal Reserve, FDIC and OCC (Mar. 12, 2023). 12. https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20230312a1.pdf. 13. FDIC and Federal Reserve Board, Joint Letter Regarding Potential Violations of Section 18(a)(4) of the Federal Deposit Insurance Act (July 28, 2022); 12 U.S.C.S. § 1828(a)(4); 12 C.F.R. § 328.102. 14. https://home.treasury.gov/system/files/261/FSOC2022AnnualReport.pdf. 15. Federal Reserve Board, FDIC, OCC, Joint Statement on Liquidity Risks to Banking Organizations Resulting from Crypto-Asset Market Vulnerabilities (Feb. 23, 2023). 16. Basel Committee on Banking Supervision, Bank for International Settlements, Prudential Treatment of Cryptoasset Exposures (Dec. 2022). 17. Id.