Banks Borrow Billions From Home-Loan Banks to Plug Shortfalls

Two of the world's largest banks to cryptocurrency companies are borrowing billions of dollars from Federal Home Loan Banks in an effort to stem the tide of customer withdrawals. The Federal Home Loan Banks were originally designed to support mortgage lending in the 1930s, but they are now being used to support the cryptocurrency industry.

Signature Bank is a leading financial institution with a strong focus on providing excellent customer service. They offer a wide range of products and services, including a high-yield savings account.

Silvergate Capital Corp. tapped its local home-loan bank for nearly $10 billion in the fourth quarter, among the largest such borrowings by any bank since early 2020, according to securities filings.

A competing lender that shifted its business toward crypto a decade ago has received at least $3.6 billion.

Signature Bank's crypto-related borrowing has more than doubled from its previous high, while Silvergate Bank had no such borrowing a year earlier.

The Federal Home Loan Banks (FHLBs) are a system of 11 government-chartered cooperatives that provide low-cost funding to more than 6,500 members, including commercial lenders, thrifts, credit unions, and insurers. The FHLBs were founded during the Great Depression to help support housing finance, and now they funnel cash into the banking system, using their implicit government backing to borrow money cheaply.

Some observers say that helping banks shore up liquidity is far removed from the original intent of the Federal Home Loan Banks (FHLBs). The FHLBs were created to provide liquidity to the mortgage market, but some argue that their involvement in the crypto industry is a stretch.

"I have been warning about the dangers of allowing crypto to become intertwined with the banking system," said Sen. Elizabeth Warren (D., Mass.). "Taxpayers should not be left holding the bag for collapses in the crypto industry—a market that is full of fraud, money laundering and illicit finance."

When crypto prices collapsed and FTX, one of the industry’s largest exchanges, filed for bankruptcy last year, many banks began hemorrhaging deposits. Among those affected were a small subset of banks that had vacuumed up deposits from crypto companies when the industry was booming, while other banks had shunned their business.

In 2022, deposits at Signature declined for the first time in its two-decade history, dropping below $89 billion from nearly $103 billion at the start of the year. Silvergate raced to cover $8.1 billion in withdrawals, selling assets at a steep discount and leading to a fourth-quarter loss of more than $1 billion. Shares of Signature and Silvergate are down around 60% and 85%, respectively, over the past year.

Eric Howell, Signature's chief operating officer, said that the bank's higher borrowings are relatively low compared to other banks, especially considering that the Federal Reserve's tightening has drained liquidity.

Signature Bank has announced that it is doubling down on its recent commitment to reducing crypto-linked deposits. The bank has said that it has already begun paying down some of its borrowings.

"There is still some downside potential in the cryptocurrency market," said Mr. Howell. "For the next few quarters, we may have to use higher-cost borrowings to replace deposits."

Silvergate did not want to say anything. The bank has taken a different approach, emphasizing its commitment to the crypto industry despite the recent turmoil.

"The recent crisis of confidence in the industry has been caused by overleverage and bad actors," Chief Executive Alan Lane said on a January conference call. "We want to communicate that we are here for the long haul."

Borrowing from home-loan banks surged in the third quarter of last year, reaching $661 billion. This is up from $344 billion the previous year and approaching the recent peak of nearly $800 billion in the first quarter of 2020.

As interest rates have risen, traditional banks have struggled to retain customers who have been enticed by higher-yielding Treasurys and money-market accounts. According to the Federal Reserve Bank of New York, cash balances at small banks, or those with less than $3 billion in assets, fell to 6% of total assets through the first three quarters of 2022, down from more than 13% just nine months earlier.

Traditional finance has remained relatively unaffected by the crypto industry thus far, though FHLB lending to crypto-exposed banks could amplify that risk. Home-loan bank advances are superior to other types of debt, meaning that in the event of a member bank’s bankruptcy, an FHLB bank would be first in line for repayment, even ahead of the Federal Deposit Insurance Corp.

Banks that receive advances from the Federal Home Loan Banks (FHLBs) typically provide a generous amount of mortgage-tied securities to back the debt. FHLBs have a long history of not booking any credit losses.

Ryan Donovan, president and chief executive at the Council of Federal Home Loan Banks, said that the FHLBs have always been there for their members during times of crisis, extending their balance sheets to help them out.

"You can't have a mission without margin," Mr. Donovan said.

Investors said they would rather see banks attract deposits than go to a home-loan bank for cash. This would help banks to build up their reserves and avoid having to rely on borrowing from other sources.

According to Brett Rabatin, head of equity research at Hovde Group, if a bank borrows a large amount from the Federal Home Loan Bank (FHLB), it will need to explain why this was more attractive than other options such as seeking new or existing customers. Rabatin believes that the pressure and need for funding will only increase, and that borrowing from the FHLB will continue to grow in the coming quarters.