Regulators Are Limiting Banks Serving Crypto Clients. Does That Violate the Law?

United States federal bank regulators have placed limits on banks servicing the crypto industry in a way that raises concerns they may be breaking federal law.

The Federal Reserve Board and Federal Deposit Insurance Corporation (FDIC) have told several banks to cap deposits from crypto companies, most often at 15% of the bank’s total deposits, in order to manage risk, according to multiple sources familiar with the matter. Sources with knowledge of the regulators’ actions say that they are additionally concerned about real-time payment platforms favored by crypto companies in which payments can be settled 24/7, even outside normal business hours. At one bank, regulators focused their crackdown entirely on payments instead of both deposits, which see lower turnover, and the settlement platform. 

The supervisory guidance, which primarily comes from the Federal Reserve Board, but also the FDIC, has made it difficult for banks to specialize in serving the crypto industry. This, in turn, has made it significantly harder for crypto companies to secure bank accounts under the Biden Administration, sources familiar with the guidance said.

Read more: Biden Nominated Christy Goldsmith Romero for FDIC Chair. What Is Her Stance on Crypto?

New, uniform policies for bank regulation must first be proposed and opened for public comment, according to the Administrative Procedure Act (APA). Some sources familiar with the supervisory guidance the Fed has given banks say the Fed may be acting without going through this formal process required by the APA. One law firm also believes that a cap on crypto deposits could violate the due process clause of the Fifth Amendment. Other sources disagree, saying their knowledge of the guidance comes as informal enforcement actions, which are not covered by the Act.

The banks affected include, but may not be limited to, Customers Bank, Cross River Bank, Western Alliance Bank, and the now-defunct Silvergate and Signature Banks. The supervisory guidance began in Q4 2022, after the collapse of crypto exchange FTX.

Spokespeople for Silvergate Bank and the FDIC declined to comment. A spokesperson for Western Alliance Bank said the company does not comment on its conversations with regulators. Customers Bank and Flagstar Bank, the second of which bought most of Signature Bank’s assets after it was in FDIC receivership, did not respond to requests for comment.

A Fed spokesperson said, “The Federal Reserve does not have a policy establishing a cap on deposits from crypto-related entities.”

The Federal Reserve Board and FDIC have denied prohibiting banks from serving any particular legal industry before, with both regulators, in conjunction with the Office of the Comptroller of the Currency (OCC), releasing a statement saying, “…Banking organizations are neither prohibited nor discouraged from providing banking services to customers of any specific class or type, as permitted by law or regulation.” Castle Island Ventures founding partner Nic Carter says that under-the-radar regulatory pressure is a key part of “Operation Choke Point 2.0,” a term he coined to refer to a Biden Administration-led regulatory regime that he argues is meant to make it difficult for the crypto industry to access stable US dollar on- and off-ramps. “Bank regulators don’t ordinarily go to banks and say, ‘You have to reduce your exposure to this specific industry to x%,’” he told Unchained. 

Silvergate’s Bombshell Filing

In mid-September, Silvergate Capital Corp. Chief Administrative Officer Elaine Hetrick said in a filing, under penalty of perjury, that Silvergate was able to manage the bank run after the fall of FTX, remaining solvent and paying all depositors as they withdrew funds. However, she said the bank chose to voluntarily wind down because the Federal Reserve and the Department of Financial Protection and Innovation (DFPI) pressured it to limit its crypto asset exposure, which made up approximately 99.5% of the bank’s deposits at the end of June 2022. 

“Following the rapid contraction of Silvergate Bank’s business, Silvergate Bank had stabilized, was able to meet regulatory capital requirements, and had the capability to continue to serve its customers that had kept their deposits with Silvergate Bank,” the filing read. “However, the increased supervisory pressure on Silvergate Bank and other banks focused on servicing crypto-asset businesses forced Silvergate Bank to a point where it would have needed to remake its business model away from its focus on crypto-asset businesses, seek to sell itself as a going concern in the shadow of the regulatory overhang or begin winding down its affairs with the goal of preserving as much value as possible for stakeholders.” 

Read more: Trump Has Made Promises to Crypto Voters. If He’s Elected, What Could He Actually Do?

Carter posted excerpts of the filing on X, claiming that it validated his previous reporting that regulators were requiring banks to drastically shrink their crypto-asset business lines, independent of evidence of systemic risk. “…Silvergate died by murder, not suicide,” he posted. 

Carter named the regulatory pressure “Operation Choke Point 2.0” because of the Obama-era “Operation Choke Point,” a coordinated effort led by the Department of Justice beginning in 2013 to make it difficult for banks to do business with short-term lenders, firearms dealers, credit boosting programs, and other companies that the administration considered at high risk for fraud and money laundering. The effort was reported by the Wall Street Journal when it obtained government memos detailing the probe. 

Two sources, including someone party to supervisory conversations, said that regulatory agencies have been careful not to put their directives to cap crypto deposits in writing, potentially to protect themselves from Freedom of Information Act requests, in which requesters can ask the government for specific, unreleased documents. Two other sources agreed that the attempt to keep this directive from appearing in writing is broadly understood amongst the regulators themselves, as well as the aforementioned banks.

“Operation Choke Point 2.0” has become shorthand in the crypto industry, used across social media and in daily conversation between employees in the sector, to refer to banking regulators’ hostility toward banks serving crypto companies. On September 24, Congressman Warren Davidson asked SEC Chair Gary Gensler if he discussed Operation Choke Point 2.0 with Federal Reserve Chair Jerome Powell during a SEC oversight hearing, to which Gensler responded that he was unfamiliar with the term. 

Video: Are Regulatory Failures to Blame for Crypto Banking Issues?

Each Bank’s Specific Guidance

The regulatory crackdown on bank deposits and settlement accounts uncovered by Unchained’s reporting began after the collapse of FTX, when regulators and politicians alike began pressuring banks to reduce exposure to the industry, which had experienced a series of collapses the year prior. 

In December 2022, Signature Bank announced it would offload $8 billion to $10 billion worth of crypto assets—to less than 15% of total deposits, according to its CEO. A source familiar with the matter told Unchained that the Fed had ordered the bank to limit crypto exposure to a maximum of 15% of deposits. (Though the prudential regulators of Signature were the FDIC and the New York Department of Financial Services, sources claimed the Fed used its decision-making authority over who can have master accounts to push the bank to change.) Another source with direct knowledge said the regulators later sharpened their stance, telling the bank to wind down its crypto exposure, both in its deposits and through its real-time payments platform Signet, entirely. The New York State Department of Financial Services took possession of the bank, naming the FDIC the receiver, on March 12, 2023. On the same day, the Federal Reserve Board did join with the OCC and the Department of the Treasury in making a systemic risk exemption for Signature Bank to ensure all its depositors were made whole, showing regulators do work in conjunction with each other.

Additionally, Hetrick said in the filing that the March closure of Signature Bank, and particularly the fact that its subsequent sale to Flagstar Bank “did not include the transfer of cash depositors related to Signature Bank’s digital asset banking business” was “illustrative of the intense regulatory pressure faced by banks in the digital assets industry at that time.” 

Customers Bank began limiting crypto deposits to 15% of its overall deposit base in February 2023, according to President and CEO Sam Sidhu. This summer, the bank entered into a consent order from the Federal Reserve Bank of Philadelphia ordering it to, within 60 days, submit a plan “acceptable to the Reserve Bank to improve risk management practices…,” indicating that the bank had been receiving supervisory guidance on crypto assets from regulators for an unclear amount of time. The consent order does not state a specific percentage of crypto deposits that would be acceptable to the Fed. However, two sources familiar with the matter told Unchained that the cap was a result of regulatory supervision.

Western Alliance Bank has not publicly acknowledged crypto deposit caps, nor has supervisory guidance or enforcement action been made public. However, two sources familiar with the bank’s operations said it has also received confidential supervisory guidance to keep crypto deposits low. 

Cross River Bank has also faced unusual regulatory pressure on crypto. Its business model is distinguished from that of the other banks in that it is more focused on settling payments than deposits. In the first quarter of 2023, Cross River Bank began taking a more cautious approach to crypto, telling Bloomberg that it was “only considering companies with existing relationships with Cross River that are blue-chip customers and integral to the fintech ecosystem.” This was after it received more than 100 requests from new clients, including crypto companies, seeking a safe harbor from the Silicon Valley Bank and Signature Bank closures, a source told Bloomberg. The bank turned down nearly all requests, this person told Bloomberg. Sources familiar with the matter say Cross River’s hesitancy to serve crypto companies at that time was the result of pressure from regulators and Cross River’s board, while one source with direct knowledge said the Federal Reserve Board and FDIC explicitly told the bank not to serve specific crypto clients. Crypto-focused Custodia Bank, which was then a Cross River customer, was de-banked at this time, losing its accounts there in February 2023, according to a source with direct knowledge. 

Video: Caitlin Long on Why Operation Choke Point 2.0 Has Bankers Nervous 

Are Regulators Skirting the Law?

It is federal bank regulators’ job to make sure that banks follow established rules and regulations and manage risk in a “safe and sound manner.” They can do this in a multitude of ways, including through formal rules, which, when broken, result in penalties for banks, as well as informal enforcement and supervisory guidance, both of which do not carry the same risk of direct punishment for banks but rather force banks to comply in order to obtain regulatory approval to establish or continue operating different business lines. This authority gives the Fed some flexibility in how they guide a specific institution based on its unique context and organizational structure. 

However, if the guidance is a uniform, informal rule, regulators would be acting in violation of the APA. The Fed has not publicly proposed a rule enforcing a 15% cap on deposits from crypto companies or on crypto exposure to real-time settlement accounts. Crypto advocates and critics are divided on whether the evidence implies they should have. 

A memo about Operation Choke Point 2.0 from law firm Cooper & Kirk, which previously challenged the original Obama-era Operation Choke Point, stated that federal regulators are acting in violation of the Administrative Procedure Act. “In conducting their campaign of informal regulation, surreptitious defamation, and backroom coercion, the bank regulators have violated the Administrative Procedure Act by acting beyond their statutory authority, without using the notice and comment rulemaking procedures required by law, and in an arbitrary and capricious manner,” the memo read. 

Read more: Law Firm’s White Paper Points to US Regulators Waging Financial War Against Crypto

Carter said that he also considers the enforcement of a cap on crypto deposits “unconstitutional.” On X, he directed readers to the Cooper & Kirk memo, which stated that the regulatory supervision on banks serving crypto is a violation of the Due Process Clause of the Fifth Amendment: “It is well settled that when a federal agency attaches a derogatory label to an individual or business, and this stigmatizing label causes the business to lose a bank account or broadly precludes them from the pursuit of their chosen trade, the agency has violated the Due Process Clause of the Fifth Amendment, unless if first afforded the individual or business a right to be heard.” 

But other law and regulatory experts disagree. Gerard Comizio, a professor of virtual currency law and the regulation of financial institutions at American University, says it’s probable that “given the facts and circumstances at that bank that they may have imposed some kind of limitations,” and that those limitations could be similar for banks that are similarly concentrated in a particular industry, like crypto. If the Fed has in its private data information to substantiate that, by having deposits overly concentrated in crypto, the individual banks find their solvency or liquidity at risk, it is not violating the APA by telling them to reduce crypto deposits, he says. 

He highlights that in the Fed’s own post-mortem on the Silicon Valley Bank crisis, the regulator pointed out that it had not required the bank to adequately diversify from venture capital and the technology sector. New York State regulators were also criticized for failing to require the diversification of credit unions serving the taxi medallion industry, which suffered greatly after the price collapse starting in 2014. “The crypto industry can’t take it too personally,” Comizio said. “It’s not good for a bank to be focused entirely on one industry.” 

Hilary Allen, a professor of financial stability regulation and new financial technologies at American University, went even further, calling the term “Operation Choke Point 2.0” “self-serving” to the crypto industry when the regulator is actually acting as it’s supposed to by telling specific banks it finds to be overly reliant on crypto to diversify their deposit bases. “It should be on the crypto banks to make the case to the regulators, to say, ‘This is what we’re proposing to do, and this is why it’s not risky. Are you on board?’” she said. “Then it’s the regulator’s job to poke holes in that because, of course, the crypto banks are going to have motivated reasoning and try and downplay the risks associated with what they’re doing.” 

Some sources familiar with the regulatory pressure say that because it is delivered as informal enforcement and supervisory guidance, it may not be a direct violation of the APA. One source with direct knowledge believes it has been too specifically tailored to each bank to be considered a uniform, informal rule, while informal enforcement is not covered by the Act. However, they still see the guidance as problematic, exposing the way that regulators can impose de facto law without giving banks any recourse, with one source calling this tactic “repugnant.” 

According to NYU professor Austin Campbell, whether or not the Fed is violating the APA comes down to whether the guidance is uniform enough to constitute an unwritten rule. “If banking regulators are making new rules with regard to crypto activities and not going through the APA, that is a problem,” he said.

Update, October 8, 11:45 a.m. ET: This article was updated to include that Custodia Bank lost its accounts at Cross River Bank around the time regulators told CR not to bank specific crypto companies.

Update, Friday, October 11, 4:30pm ET: The article has been updated to include how the Fed had decision-making authority over Signature and Cross River, despite not being the prudential regulator of either. It also now includes an example of how the Fed, along with the OCC and the Department of the Treasury all worked together in regulating Signature.