What really happened to Signature Bank NY?

 


As the world reeled in shock at the sudden collapse of Silicon Valley Bank (SVB), another bank quietly went under. On Sunday 12th March, the U.S. Treasury, Federal Reserve and FDIC announced that all SVB depositors, whether insured or not, would have access to their funds from Monday. And then they added: 

We are also announcing a similar systemic risk exception for Signature Bank, New York, which was closed today by its state chartering authority.

Signature Bank NY's state chartering authority was the New York State Department of Financial Services (NY DFS). It posted this on its website

On Sunday, March 12, 2023, the New York State Department of Financial Services (DFS) took possession of Signature Bank in order to protect depositors. All depositors will be made whole. 
DFS has appointed the Federal Deposit Insurance Corporation (FDIC) as receiver, and the FDIC has transferred all of the deposits and substantially all of the assets of Signature Bank to Signature Bridge Bank, N.A., a full-service bank that will be operated by the FDIC as it markets the institution to potential bidders.

So the NY DFS closed down Signature Bank NY (SBNY) and handed it over to the FDIC for resolution. 

Unlike California's Department of Financial Protection and Innovation, the NY DFS didn't have to get a court order to close down its bank. It simply exercised its powers under Section 606 of the New York Banking Act. Those powers are extremely wide-ranging: 


We could summarise this as "we can close you down at any time, without notice, if we don't like what you are doing". 

The NY DFS gave no explanation for its decision to close SBNY down, nor for putting it into FDIC receivership. It didn't even identify which clauses in the above list it relied upon. Lots of people were puzzled, because on paper, SBNY looked solvent: its 10-K regulatory filing, announced in February 2023, reported that at 31st December 2022, it had $110.36bn of assets and $88.59bn in deposits. True, it had weaknesses: like Silvergate, it provided specialist depository and payment services to crypto exchanges and platforms, and as a result had a high proportion of uninsured and highly runnable deposits. And like Silvergate, it was carrying unrecognised fair value losses on its securities portfolio. But it had a large, and apparently sound, real estate lending portfolio. And its uninsured deposits had grown substantially in the previous week, as many crypto exchanges and platforms had moved their funds to it from Silvergate Bank. So why had the NY DFS closed it down without warning? 

I thought rapid inflows from Silvergate might have overwhelmed SBNY's administration and control systems, rendering it no longer in a safe and sound condition (clause (c)) and unable to safely continue in business (clause (d)). But this might have been temporary, and Section 606 allows for temporary closures, for example to prevent bank runs due to contagion rather than fundamentals. SBNY's books didn't look too bad, so I wondered why the NY DFS had put SBNY straight into receivership. Did it think SBNY was "conducting its business in an unauthorized or unsafe manner" (clause (b))? Did it close down SBNY because of suspected complicity in FTX/Alameda's wire fraud (clause (a))? Or had SBNY suffered impairment to its capital as a result of Silvergate contagion (clause (e))? I didn't know, but I thought there must have been some kind of catastrophic failure to justify such drastic action. 

But crypto people smelled a rat. After Silvergate went into voluntary liquidation, SBNY was the only major provider of banking services to crypto companies. It had already announced its intention to reduce its exposure, but perhaps this wasn't enough for regulators that were increasingly unfriendly to crypto activities. Could the regulators have used the smokescreen created by SVB's failure as an opportunity to close down a bank that was engaged in business they didn't like?

Then Barney Frank stepped in. Frank was joint author of the Dodd-Frank bank regulations introduced in response to the 2008 banking crisis - and a director of SBNY. Completely ignoring the bank's crypto-related activities, Frank insisted that the bank was sound, telling Bloomberg:

I think that if we’d been allowed to open tomorrow, that we could’ve continued — we have a solid loan book, we’re the biggest lender in New York City under the low-income housing tax credit. I think the bank could’ve been a going concern.”

Following Frank's intervention, the idea that SBNY was a solvent bank unfairly closed down by regulators spread like wildfire. Only a month before, the crypto entrepreneur Nic Carter had published an article claiming that the Biden administration was intending to choke off crypto companies' access to the US banking system in the same way that the Obama administration had choked off access for payday lenders. Carter called this plan "Operation Chokepoint 2.0". To many people, the closure of SBNY was evidence that Carter was right. "Operation Chokepoint 2.0" was real, and it was here. 

The law firm Cooper & Kirk, which says it "successfully challenged" President Obama's Operation Choke Point (though the case never reached court), has now published a paper purporting to prove the existence of Operation Chokepoint 2.0. This paper, somewhat grandly entitled "The Federal bank regulators come for crypto", lists the manifold ways in which it says regulators are denying crypto people their constitutional rights. These include: failing to charter crypto-friendly banks (Protego); demanding that existing banks exit crypto-related activities; refusing Federal Reserve master accounts to state banks engaged in crypto-related business (Custodia, Kraken); and closing down a solvent bank (SBNY) solely because of its crypto-related activity: 

Finally, the federal bank regulators are acting in an arbitrary and capricious fashion by failing to adequately explain their decisions, by failing to engage in reasoned decisionmaking, and by failing to treat like cases alike. It is difficult to imagine a more arbitrary and capricious agency action than simultaneously placing a solvent bank into receivership solely because it provided financial services to the crypto industry, while permitting insolvent institutions not tied to the crypto industry to continue operating.  

Now, it is probably true that the US regulators are clamping down on the crypto industry with  the intention of driving much of it out of the US. The fall of FTX crystallised the risks that a largely unregulated crypto system poses to ordinary depositors and to the financial system. In January 2023, the Fed/FDIC/OCC brutally listed these risks in their joint statement on crypto-asset risks to banks:


Cooper & Kirk, following Carter, claim this statement is evidence of the US regulators' ill-will towards the crypto industry. But in the past year, every one of the risks and abuses that the regulators list has been evident in the crypto world. And as a result, many people have lost money they could ill afford. 

It is hard to see that regulatory action intended to protect people from such behaviour is unreasonable. And it is therefore also hard to see why such action should be seen as an unfair and illegal conspiracy against legitimate businesses. In fact it could be argued that the regulatory clampdown is a fine example of shutting the stable door after the horses have absconded with large amounts of people's money. Regulators are tasked with protecting the public, and they have manifestly failed to do so. This is the real scandal, not a fictitious "chokepoint" invented by people desperate to preserve a business model built on avoiding regulation.   

In February, the Fed, FDIC and OCC went on to warn banks about liquidity risks arising from crypto-related activities. This statement in particular proved exceptionally prescient: 

When a banking organization’s deposit funding base is concentrated in crypto-asset-related entities that are highly interconnected or share similar risk profiles, deposit fluctuations may also be correlated, and liquidity risk therefore may be further heightened.

Less than a month later, highly interconnected depositors all removing their funds at the same time brought down both Silvergate Bank and SVB. 

And we now know that despite the inflows earlier in the week, this was also what brought down SBNY. In his testimony to the House Financial Services Committee, FDIC chairman Martin J. Gruenberg gave the first comprehensive description of the events that led to the closure of SBNY. It's quite a story. 

Like Silvergate, SBNY's troubles began with the fall of FTX:

Signature Bank was subject to media scrutiny following the bankruptcy of FTX and Alameda Trading in November 2022, as the bank had deposit relationships with both. Subsequently, in December 2022, Signature Bank announced that it would reduce its exposure to digital asset related deposits. These declines were funded primarily by cash and borrowings collateralized with securities.

In February 2023, Signature Bank was again subject to media attention when a lawsuit was filed alleging it facilitated FTX commingling of accounts.

SBNY then suffered contagion from Silvergate: 

Following the March 1, 2023 announcement by Silvergate Bank regarding the delay in filing its year-end 2022 financial statements and comments about its ability to continue as a going concern, Signature Bank once again experienced negative media attention, which raised questions about its liquidity position. This attention continued as Silvergate Bank later announced its self-liquidation.

And from SVB too:  

Subsequently, as word of SVB’s problems began to spread, Signature Bank began to experience contagion effects with deposit outflows that began on March 9 and became acute on Friday, March 10, with the announcement of SVB’s failure.

On Friday 10th March, SBNY suffered a massive bank run, losing 20% of its deposits in a single day. The only reason this didn't make headline news was that SVB's failure swamped the airwaves.  

Losing deposits at that rate is catastrophic for a bank. Like SVB, SBNY quickly ran up an unauthorised overdraft at the Federal Reserve. Banks are not allowed to maintain overdrafts in their reserve accounts overnight, so SBNY had to convert the overdraft to discount window borrowing before close of business on Friday 10th March. It barely made it:

Bank management could not provide accurate data regarding the amount of the deficit, and resolution of the negative balance required a prolonged joint effort among Signature Bank, regulators, and the Federal Home Loan Bank of New York to pledge collateral and obtain the necessary funding from the Federal Reserve’s Discount Window to cover the negative outflows. This was accomplished with minutes to spare before the Federal Reserve’s wire room closed.

But in these days of instant electronic payments, people can remove their funds from a bank even when the bank is closed for the weekend. So the bank run didn't stop:

Over the weekend, liquidity risk at the bank rose to a critical level as withdrawal requests mounted, along with uncertainties about meeting those requests, and potentially others in light of the high level of uninsured deposits, raised doubts about the bank’s continued viability.

According to Barney Frank, deposit ouflows had slowed by Sunday, and SBNY management believed they had stabilised the situation. But it seems NY DFS thought otherwise. On Sunday afternoon, it shuttered the bank. 

Would SBNY have been able to continue if it had opened on Monday? It seems unlikely. SBNY was already critically short of eligible collateral, and reopening on Monday would likely have reignited the bank run. A bank that has insufficient eligible collateral to tap the Fed's discount window for funding to meet its obligations is insolvent, not merely illiquid. And I don't mean insolvent in the sense that its assets are worth less than its liabilities, though that was probably also true. I mean that it is unable to meet its obligations as they fall due. That is the textbook definition of insolvency

And this explains why the NY DFS not only closed SBNY down, but handed it over to FDIC for resolution. The catastrophic run it had suffered had rendered it insolvent. 

I checked the references in Cooper & Kirk's paper. Their claim that SBNY was solvent rests entirely on the word of Barney Frank as reported by CNBC. And his belief that the bank was solvent in turn rested entirely on what he was being told by SBNY's management.  In fact Cooper & Kirk's theory that regulators deliberately closed down a solvent bank is really nothing but the unsupported opinion of Barney Frank. If this part of their case is so weak, what does it say about the rest?

Of course, believers in Operation Chokepoint 2.0 will reasonably point out that Gruenberg is the only person who has described the fall of SBNY in such detail. Gruenberg was of course testifying to a House committee, rather than simply giving a personal opinion to a media publication, so his words should carry more weight. But nevertheless it is a valid criticism. Had NY DFS published the rationale for its decision at the time, as California's DFPI did in its court filing, the idea that regulators had closed down a solvent bank would never have gained traction. After all, no-one dares question California DFPI's decision to close down SVB. 

Regulators need to be a lot more transparent about their decisions. And law firms need to remember that the unsupported opinion of one person with a vested interest is not evidence. The public has a right to know the truth. 

Related reading:

Silvergate Bank - a post mortem

Anatomy of a bank run

What now for crypto banking? - Coindesk

Federal Reserve's order denying Custodia Bank's application for membership

Image: Reporters outside Signature Bank New York. By SWinxy - Own work, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=129570493

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