Crypto-friendly bank Customers Bank is under Federal Reserve scrutiny: what does it mean?

Source: AiYing Compliance

As the cryptocurrency industry continues to expand in the United States, the attention of regulators is also increasing. Last week on August 8, the Federal Reserve took a major enforcement action against Pennsylvania-based Customers Bank, marking the U.S. government's gradual increase in regulatory supervision of cryptocurrency-related businesses.

As a financial institution serving the cryptocurrency industry, Customers Bank has attracted a large number of customers in recent years through its digital asset services and the distributed ledger-based Customer BankInstantTransfer (CBIT) platform. Customers Bank is one of the few remaining U.S. banks that can support larger-scale businesses after Signature Bank and Silvergate Bank. Some big names in the crypto industry, including Galaxy Digital, Coinbase and Circle, are also its main customers.

However, this has also attracted close attention from regulators. The Federal Reserve Board found "significant deficiencies" in management and anti-money laundering (AML) compliance in its "recent inspections and reviews" of the bank, which are considered to be hidden dangers that could pose a threat to the financial system. This is consistent with an article written by Aiying in June, "Crypto-friendly Bank Customers Bank Cleans Up Inactive Accounts: Crypto Hedge Funds May Face Account Opening Difficulties" - According to three people familiar with the matter, Customers Bank has notified some hedge fund customers that it can no longer provide them with banking services. Now there is a clearer reason.

Specifically, the Federal Reserve Board issued a 13-page enforcement document Requires Customers Bank to provide 30 days' notice before establishing a new banking relationship with any cryptocurrency company in the future. More severely, the bank must overhaul its risk management and anti-money laundering compliance program, especially when dealing with cryptocurrency-related businesses. This is not only a strict constraint on Customers Bank, but also a warning to the entire cryptocurrency industry, showing that the US government is taking more stringent measures to control this emerging field. The following are the main requirements of Aiying's law enforcement documents:

• Board supervision:The board of directors of Bancorp and Bank must submit a plan within 60 days to strengthen supervision of institutional management and operations to ensure compliance with BSA/AML and OFAC regulations.

• Risk management:A risk management plan to improve digital asset strategies must be developed, including formulating policies, ensuring that personnel have expertise, and providing sufficient resources.

• BSA/AML compliance plan:Bankmust submit a revised BSA/AML compliance plan within 60 days to ensure compliance with relevant regulatory requirements and conduct a comprehensive risk assessment.

• Customer due diligence:The customer due diligence procedures must be revised to ensure that complete and accurate information on all customers is collected, analyzed, and preserved.

• Monitoring and reporting of suspicious activities:The monitoring system needs to be improved to ensure that all known or suspected illegal or suspicious transactions are identified and reported in a timely and accurate manner.

• Transaction review:Bank needs to hire a third-party independent consultant to review transaction monitoring activities within a specified time period to ensure that suspicious activities are appropriately identified and reported.

• OFAC compliance:A plan to enhance OFAC compliance needs to be submitted, including improved screening procedures and risk assessment methods.

• The boards of directors of Bancorp and Bank are required to submit progress reports within 45 days after the end of each quarter, detailing the measures taken to comply with this agreement and their results.

According to Aiying, this regulatory action has had a direct impact on Customers Bank. After the Federal Reserve announced this decision, the bank's stock price fell by more than 20% at one point. Although the decline eventually narrowed to 13.3%, this market reaction undoubtedly reflects investors' concerns about regulatory pressure.

Later, Customers Bank said it was taking a series of measures to respond to the Federal Reserve's requirements, promising to strengthen its risk management practices and anti-money laundering compliance procedures. The bank's chief risk officer, Joan Cheney, said in a statement that the bank is committed to meeting regulators' expectations and is working to correct the problems found.

The mutual impact of the crypto industry and the banking industry's liquidity stress test

Recently, Tether's CEO Paul Ardoino expressed his strong dissatisfaction with the MiCA regulations in an interview. The MiCA regulations officially came into effect on June 30, 2023, imposing strict restrictions on stablecoin and cryptocurrency businesses. The regulations stipulate that all stablecoin issuers operating in the European Economic Area must ensure that at least 60% of reserve funds are deposited in EU bank accounts. For details, please read "In-depth Analysis and Latest Adjustments of EU MiCA Act's Restrictions on the Use of Stablecoins", "European MiCA Act 10,000-word Research Report: Comprehensive Interpretation of the Far-reaching Impact on Web3 Industry, DeFi, Stablecoins and ICO Projects". He pointed out that although the original intention of the regulations was to enhance system security, in fact, such regulations may cause "huge systemic risks". Ardoino specifically mentioned that financial institutions usually adopt a partial reserve banking system, that is, banks only keep a small portion of deposits as available funds, and most of the funds are used for other investments or loan businesses. This means that if a bank has liquidity problems, it may not be able to meet the large-scale withdrawal needs of depositors, thus triggering a bank run.

This is easy to understand. You should know that since March 2020, due to the economic impact of the new crown epidemic, the Federal Reserve has lowered the bank's reserve ratio to 0, which means that US banks currently do not need to hold legal reserves. In theory, according to the theory of money multiplier, deposit money can be created infinitely. Of course, there are also realistic conditions such as the 8% adequacy ratio required by the Basel Accord, market loan demand restrictions and other factors that cannot be achieved, but it is a fairly loose requirement, which means that if the bank has 1 dollar in its pocket, it can actually make hundreds of dollars in loans, and the leverage is full. Therefore, if there is a slight liquidity shortage that leads to a bank run, basically no bank can escape the thunder.

Therefore, in early 2023, the US banking industry experienced a serious crisis, and Silicon Valley Bank, Signature Bank and Silvergate Bank went bankrupt one after another. In addition, First Republic Bank also collapsed in May. Although PacWest Bancorp, Western Alliance Bancorporation, Zions Bancorporation and Comerica Incorporated did not collapse, they also faced severe challenges such as stock crashes, deposit outflows and market panic. Circle deposited part of its USDC reserves in Silicon Valley Bank. This indirectly led to the depegging of USDC, and the exchange rate against the US dollar fell to about $0.87. The latter crisis benefited from the intervention of the Federal Deposit Insurance Corporation (FDIC). For failed banks such as Silicon Valley Bank, Signature Bank and First Republic Bank, the FDIC quickly took over the assets and liabilities of these banks to protect the interests of depositors. The Federal Reserve also launched the Bank Term Funding Program (BTFP) during the crisis to provide banks with additional liquidity support to cope with deposit outflows and tight liquidity. These measures quickly intervened to help curb market panic and prevent the further spread of the crisis. Otherwise, USDC may become the second UST with a high probability. The chain reaction will cause liquidity shortages like USDT, BUSD and other banking institutions. No bank can really withstand the test of a run. Therefore, if liquidity remedial measures were not taken immediately, it is not an exaggeration to say that the market value of the entire crypto industry may shrink by more than 60% (personal subjective judgment).

Whether in Hong Kong, Singapore, Europe and other regions, stablecoin issuers must ensure that sufficient reserve funds are deposited in bank accounts. If it is 100% reserve, the risk is on the bank. If the bank has liquidity problems one day, it will be unlucky. If it is less than 100%, then the stablecoin issuer is actually acting as a "shadow bank", adding another layer of leverage on top of the leverage of the bank's reserve ratio and money multiplier, which is equivalent to further amplifying the bank's own liquidity risk coefficient.

According to Aiying’s understanding of some leading institutions, due to the risk preference of the banking system, they have a bias or aversion to crypto institutions. Therefore, the cash of these stablecoin issuers, OTC institutions, custodians, etc. is basically concentrated in a few bank accounts that can be opened, and some of them are unknown small banks to meet the business transfer needs. Therefore, the situation of the triple kill of stocks, bonds and currencies in the European, American and Japanese markets last week shows that the market liquidity is still in a very tight state, but it has not yet involved the "heart" ischemia like Silicon Valley Bank and Credit Suisse, one of the world's largest financial institutions. This time it is more like a symptom of leg cramps. In general, from the perspective of traditional Chinese medicine, it is a deficiency of both qi and blood. Before the blockage is unblocked, this is a precursor to "stroke". Therefore, when Aiying communicates with friends in surrounding institutions, she also reminds them to pay attention to bank accounts, try to diversify risks, or not to blindly expand business and capital volume before the blockage is unblocked.