Is Signature Bank making the right choice in reducing its exposure to crypto deposits?

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At a recent conference, executives at Signature Bank (SBNY 1.98%) announced that they plan to cut a large chunk of deposits associated with the bank’s digital assets following the FTX debacle, which rocked the entire crypto industry.

Signature Bank is one of the few US banks currently serving crypto exchanges and clients. The bank does not hold cryptocurrencies but has developed a real-time payment platform, which is particularly useful for cryptocurrency trading because cryptocurrencies are traded around the clock, while a much of the US banking system operates with a lag. In exchange for using the payment platform, which is called Signet, customers provide the bank with large sums of interest-free deposits, on which Signature pays no interest.

Crypto banking clients have become 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 choice in reducing these crypto deposits?

The fallout from FTX

Crypto banking customers have been beneficial due to non-interest bearing deposits, which the bank can invest in other interest-earning assets and earn 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 that growth was in non-interest-bearing deposits, much of which came from customers. of digital assets. At the end of the third quarter of this year, Signature had nearly $103 billion in total deposits, of which approximately $23.5 billion belonged to digital asset customers.

Now, some of that massive growth was tied to the Federal Reserve pumping a ton of excess liquidity into the economy after the pandemic began, as well as Bitcoin’s huge surge in 2021, which has pushed many investors into the space. Deposits tied to digital assets had actually started to decline earlier this year as cracks appeared in the crypto market and the Fed began to unwind its massive balance sheet, essentially pulling cash out of the economy.

But the collapse of FTX sent shockwaves 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 FTX deposits, but the stock is still down nearly 18% in the past month.

Another bank that runs a similar payments platform, Silvergate Capital, held around 10% of its digital asset deposits with FTX and has seen its stock plunge nearly 44% in the past month. Silvergate also faced extreme pressure from short sellers and questions from lawmakers about whether it had the proper anti-money laundering and secrecy law protocols in place. banking.

At a conference yesterday, Signature’s chief financial officer, Eric Howell, said the bank would seek to reduce its crypto deposits from 23% of the total deposit base to 20% in the short term and then to 15%. This means reducing deposits by $8 billion to $10 billion. Howell also said that going forward, no client will be able to hold more than 2% of total deposits.

“We also recognize that it’s important for us to have a diverse funding base,” Howell said. “We’re not just a crypto bank and we want that to be clear and clean.”

Is Signature making the right choice?

This move by Signature appears to be in line with the bank’s risk tolerance, and given the pressure Silvergate is under, management likely sees this as a reasonable course of action. Given that no one seemed to see FTX’s collapse coming, it’s certainly fair to wonder if there might be other potential issues lurking in the industry.

However, I don’t like this decision. The bank is abandoning non-interest-bearing deposits in an environment where the battle for deposits is only intensifying. Also, slower deposit growth will likely lead to slower loan growth next year, as banks need deposits to fund loans.

Plus, what really made Signet so valuable to join was the network effect. To send payments to someone in real time on Signet, you must be on Signet. So the idea is that as the network grows, it becomes more attractive to join because it becomes almost a necessity for people in the space. This would have allowed Signature to build a bigger moat.

But by limiting the concentration of deposits and the number of deposits the bank can have, Signature really limits the potential for this network effect, which could make Signet less appealing to crypto clients. Perhaps Signature is eventually considering moving away from crypto repositories altogether or waiting for a time when there is greater interoperability between these real-time payment networks.

Signature has plenty of other promising companies and is now trading at a very depressed valuation, so it’s not necessarily a bad stock to own. But it’s entirely possible that the crypto will bounce back and become popular again, and Signet is definitely one of the companies that has been driving the stock around in recent years.

Bram Berkowitz 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.

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