At a recent conference, executives from signature bank (sbny 0.28%) announced that they plan to liquidate a large portion of the bank's digital asset-associated deposits in the wake of the FTX debacle, which has rocked the entire cryptocurrency industry.
Signature Bank is one of the few banks in the US that currently offers cryptocurrency exchanges and clients. The bank does not hold cryptocurrency, but has developed a real-time payments platform, which is particularly useful for cryptocurrency trading because cryptocurrency trades around the clock, while much of the US banking system operates on lag. . In exchange for using the payment platform, which is called Signet, customers provide large amounts of non-interest-bearing deposits to the bank, on which Signature pays no interest.
Banking crypto clients became an incredibly strong business for Signature in 2021 and helped drive the bank's shares to extraordinary levels last year. Is Signature making the right move by reducing these crypto deposits?
The consequences of FTX
Banking crypto customers have been beneficial because of the non-interest-bearing deposits, which the bank can invest in other interest-bearing assets and earn money on the spread. Bank investors love banks with cheap and rigid deposit bases.
Image source: Getty Images.
In 2021, Signature grew its total deposits from less than $62 billion to more than $100 billion, and more than half of this growth was in non-interest-bearing deposits, many of which came from digital asset clients. At the end of the third quarter of this year, Signature had close to $103 billion in total deposits, of which approximately $23.5 billion belonged to digital asset clients.
Now, part of this massive growth had to do with the injection of a ton of excess liquidity into the economy by the Federal Reserve after the pandemic started, as well as the huge increase in Bitcoin in 2021, which attracted many investors to the space. Deposits related to digital assets had actually started to decline earlier this year as cracks emerged in the crypto market and as the Fed began unwinding its massive balance sheet, essentially pulling liquidity out of the economy.
But FTX collapse it sent a shockwave through the industry, spreading a lot of contagion to other big crypto players. Fortunately for Signature, the bank only had a very small number of FTX deposits, but shares are still close to 18% over the past month.
Another bank that operates a similar payment platform, Silvergate Capital, held around 10% of its deposits from FTX digital assets and has seen its shares fall nearly 44% over the past month. Silvergate has also faced extreme pressure from short sellers and questions from lawmakers about whether it had proper anti-money laundering and Bank Secrecy Act protocols in place.
In a conference call yesterday, Signature CFO Eric Howell said the bank will look to reduce its crypto deposits from 23% of the total deposit base to 20% in the short term and eventually to 15%. That means a reduction from $8 billion to $10 billion in deposits. Howell also said in the future that no client will be allowed to have more than 2% of the total deposits.
"We also recognize that it is important for us to have a diversified funding base," Howell said. โWe are not just a crypto bank and we want that to come across loud and clear.โ
Is Signature making the right move?
This move by Signature appears to be in line with the bank's risk tolerance, and given the pressure Silvergate is experiencing, management likely sees this as a reasonable course of action. Considering that no one seemed to see the FTX crash coming, it's certainly fair to wonder if other potential problems could be lurking in the industry.
However, I do not like this decision. The bank is waiving non-interest-bearing deposits in an environment where the battle for deposits is about to get fiercer. Also, slower deposit growth will likely lead to slower loan growth next year as banks need deposits to fund loans.
Also, what really made Signet so valuable to join is the network effect. To send someone real-time payments on Signet, you must be on Signet. So the idea is that as the network grows, it becomes more attractive to join because it almost becomes a necessity for people in the space. This would have allowed Signature to build a larger moat.
But by limiting deposit concentration and the number of deposits the bank can hold, Signature is really limiting the potential for this network effect, which could make Signet less attractive for crypto clients to join. Maybe Signature is finally planning to leave crypto deposits together or waiting for a time when there is greater interoperability between these payment networks in real time.
Signature has plenty of other promising businesses and is now trading at a very depressed valuation, so it's not necessarily a bad stock. But it's very possible that cryptocurrencies could recover and become popular again, and Signet is really one of the companies that has driven stocks in recent years.
Bram Berkowitz He has positions in Bitcoin and Silvergate Capital. The Motley Fool has positions and recommends Bitcoin. The Motley Fool recommends Silvergate Capital. The Motley Fool has a disclosure policy.
