At a recent conference, executives from Signature Bank (SBNY) announced that they are planning to wind down a large chunk of the bank's digital asset-associated deposits in the wake of the FTX debacle, which has shaken the entire crypto industry.
Signature Bank is one of the few U.S. banks currently serving crypto exchanges and clients. The bank doesn't hold cryptocurrencies but has developed a real-time payments platform, which is particularly helpful to crypto trading because cryptocurrencies trade around the clock, while much of the U.S. banking system operates on a lag. In return for using the payments platform, which is called Signet, clients bring large sums of non-interest-bearing deposits to the bank, which Signature pays no interest on.
Banking crypto clients turned into an incredibly strong business for Signature in 2021 and helped drive the bank's stock to extraordinary levels last year. Is Signature making the right move by reducing these crypto deposits?
The fallout from FTX
Banking crypto clients have been beneficial because of the non-interest-bearing deposits, which the bank can invest in other interest-earning assets and make money on the spread. Bank investors love banks with cheap and sticky 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, a lot of which came from digital asset clients. At the end of the third quarter of this year, Signature had close to $103 billion of total deposits, roughly $23.5 billion of which belonged to digital asset customers.
Now, some of this massive growth had to do with the Federal Reserve pumping in a ton of excess liquidity into the economy after the pandemic started, as well as the huge run-up of Bitcoin in 2021, which drove a lot of investors to the space. Digital asset-related deposits had actually begun to decline earlier this year as cracks emerged in the crypto market and as the Fed began to unwind its massive balance sheet, essentially pulling liquidity out of the economy.
But the collapse of FTX sent a shock wave through the industry, spreading a lot of contagion to other big crypto players. Luckily for Signature, the bank only had a very small amount of deposits from FTX, but the stock is still down close to 18% over the past month.
Another bank that runs a similar payments platform, Silvergate Capital, had about 10% of its digital asset deposits from FTX and has seen its stock plummet almost 44% over the past month. Silvergate has also faced extreme pressure from short-sellers and questions from lawmakers about whether it had the proper anti-money laundering and Bank Secrecy Act protocols in place.
At a conference yesterday, Signature CFO Eric Howell said that the bank will look to reduce its crypto deposits from 23% of the total deposit base to 20% in the near term and then eventually down to 15%. That means shrinking by $8 billion to $10 billion deposits. Howell also said in the future that no one client will be able to have more than 2% of total deposits.
"We also recognize that it's important for us to have a diversified funding base," Howell said. "We're not just a crypto bank and we want that to come across loud and clear."
Is Signature making the right move?
This move by Signature seems to be in line with the bank's risk tolerance, and considering the pressure Silvergate is seeing, management likely sees this as a reasonable course of action. Considering no one seemed to see the FTX meltdown coming, it's certainly fair to wonder whether other potential problems might be lurking in the industry.
However, I don't love this decision. The bank is giving up non-interest-bearing deposits in an environment where the battle for deposits is only about to get more fierce. Furthermore, the slower deposit growth will likely lead to slower loan growth next year, as banks need deposits to fund loans.
Additionally, what really made Signet so valuable to join is the network effect. To send payments to someone in real-time on Signet, you have to be on Signet. So the idea is that as the network grows it gets more attractive to join because it almost becomes a necessity for people in the space to be on. This would have allowed Signature to build a bigger moat.
But by limiting the deposit concentration and the number of deposits the bank can have, Signature is really limiting the potential of this network effect, which could make Signet less attractive for crypto clients to join. Perhaps Signature is eventually planning to exit crypto deposits altogether or waiting for a time when there is greater interoperability between these real-time payment networks.
Signature has plenty of other promising businesses and now trades at a very depressed valuation, so it's not necessarily a bad stock to own. But it's quite possible that crypto bounces back and becomes popular once again, and Signet is really one of the businesses that had driven the stock in recent years.
