What Crypto’s Falling Dominoes Could Mean for Banks

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On Nov. 11, the cryptocurrency exchange FTX declared bankruptcy. It’s a saga that’s played out through November, but here’s the bare bones of it: After a Nov. 2 CoinDesk article raised questions about FTX and a sister research firm, a rival exchange, Binance, announced on Nov. 6 its sale of $529 million of FTX’s cryptocurrency. In a panic, customers then sought to withdraw $6 billion and by Nov. 10, FTX CEO Sam Bankman-Fried was trying to raise $8 billion to keep the exchange alive.

This isn’t just a modern version of the old-fashioned bank run. FTX’s new CEO, John J. Ray III — who led the restructuring of Enron Corp. in 2001 — stated in a filing that he’s never seen such a “complete failure of corporate controls” in his 40 years of experience. “From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented,” he said.

The fallout promises serious ramifications for the digital assets space — and may impact some banks. BlockFi, another cryptocurrency exchange that was bailed out by FTX last summer, filed for bankruptcy protection on Nov. 28. Those two bankruptcies have impacted Memphis, Tennessee-based, $1.3 billion Evolve Bank & Trust, which operates a banking as a service platform for fintechs including FTX.

The bank stated its exposure to FTX was in deposit accounts for a limited number of FTX customers, whose funds would be released once Evolve gets approval from the bankruptcy court handling the FTX case. Evolve also issued credit cards for BlockFi customers through a relationship with Deserve; those accounts were suspended. “Evolve has no financial exposure to BlockFi or to the credit card program they marketed,’’ Evolve said in a statement Thursday.

“To be clear, Evolve did not lend to FTX or their affiliates; we do not have corporate or deposit accounts with FTX or their affiliates; we do not lend against crypto; we do not offer crypto custodial services; and, we do not trade crypto,” Evolve said in an earlier statement to customers. Evolve also said the bank has never invested or transacted in crypto.

A larger bank also appears to be impacted. La Jolla, California-based Silvergate Capital Corp., with $15.5 billion in assets, said in a statement that its FTX exposure was less than 10% of its $11.9 billion in digital assets deposits; it later said that BlockFi deposits comprised less than $20 million. However, funds from digital assets clients make up 86% of Silvergate’s deposit base, according to its most recent earnings presentation. The rest are brokered, explains Michael Perito, a managing director at Keefe, Bruyette & Woods. And now, he says, “their targeted core customer base is under a lot of stress.” As a result, Kroll Bond Ratings Agency placed Silvergate’s ratings on watch downgrade on Nov. 21.

“As the digital asset industry continues to transform, I want to reiterate that Silvergate’s platform was purpose-built to manage stress and volatility,” said Alan Lane, CEO of Silvergate, in a press release. The bank declined comment for this article.

FTX may be the worst but it’s not the only crypto-related incident this year; it’s not even the first bankruptcy. The volatility has resulted in what has been dubbed a crypto winter, marked by a steep decline in prices for digital assets. The price for bitcoin peaked on Nov. 8, 2021, at $67,567. As of Nov. 29, 2022, that value hovered just above $16,000, with a market cap of $316 billion.

Even if banks don’t hold cryptocurrency on their balance sheets, there are many ways that a chartered institution could be directly or indirectly connected. Erin Fonté, who co-chairs the financial institutions corporate and regulatory practice at Hunton Andrews Kurth, advises all banks to understand their potential exposure.

She also believes that crypto could be at an inflection point. “Some of the non-sexy elements of financial services are the ones that keep you safe and stable and able to operate,” says Fonté. “It’s the compliance function, it’s the legal function, it’s proper accounting and auditing, internal and external. It’s all those things that banks do day in and day out.”

That could result in more regulation around crypto, and more opportunities for banks. “A lot of people are getting hurt, and have gotten hurt this year,” says Lee Wetherington, senior director of corporate strategy at Jack Henry & Associates. “That gets legislative attention and that certainly gets regulatory attention.”

What Could Change
Legislation could target crypto exchanges directly, but legislators are also looking at the banking sector. In a Nov. 21 letter, the Senate Banking Committee urged bank regulators to continue monitoring banks engaged in digital assets. They specifically called out SoFi Technologies, which acquired a chartered bank in February 2022 and subsequently launched a no-fee cryptocurrency purchase option tied to direct deposits. “SoFi’s digital asset activities pose significant risks to both individual investors and safety and soundness,” wrote the legislators. “As we saw with the crypto meltdown this summer … contagion in the banking system was limited because of regulatory guardrails.”

In a statement on SoFi’s Twitter account, the company maintained that it has been “fully compliant” with banking laws. “Cryptocurrency remains a non-material component of our business,” SoFi continued. “We have no direct exposure to FTX, FTT token, Alameda Research, or [the digital asset brokerage] Genesis.”

Currently, the Federal Reserve and Federal Deposit Insurance Corp. require notification from banks engaged in crypto-related activities; the Office of the Comptroller of the Currency takes that a step further, requiring banks to receive a notice of non-objection from the agency. More regulation is likely, says Fonté, and could include investor and consumer protections along with clarity from the Securities and Exchange Commission and Commodity Futures Trading Commission. “There’s a lot that’s going to come out there that is going to reshape the market in general, and that may further define or even open up additional avenues for banks to be involved if they want to be,” she adds.

Opportunities in crypto and a related technology called blockchain could include retail investment products, international payments capabilities or trade settlement, or payments solutions for corporate clients that leverage blockchain technology — such as those offered by Signature Bank, Customers Bancorp and Silvergate.

The risks — and opportunities — will vary by use case. “We’re being presented with entirely new risks that haven’t existed in the past,” says John Epperson, a principal at Crowe LLP.

Banks could be seen as a source of safety and trust for investors who remain interested in cryptocurrency. Larry Pruss, managing director of digital assets advisory services at Strategic Resource Management, believes banks could win back business from the crypto exchanges. “You don’t have to compete on functionality. You don’t have to compete on bells and whistles. [You] can compete on trust.”

James Wester, director, cryptocurrency at Javelin Strategy & Research, believes that with the right technology partners, banks can approach cryptocurrency from a position of strength. “We understand this stuff better,” he explains. “We understand how to present a financial product to our consumers in a safer, better, more transparent way.”

Wetherington recommends that banks consider cryptocurrency as part of a broader wealth offering. He’s visited bank boardrooms that have looked at how PayPal Holdings and other payments providers offer users a way to buy, sell or hold digital assets, and whether they should mimic that. And they’ve ultimately chosen not to mirror these services due to the reputational risk. “You can’t offer buy, hold and sell of a single asset class that is materially riskier than any number of more traditional asset classes,” he says. “If you’re going to offer the ability to buy, hold and sell a cryptographic monetary asset, you should also be making available the opportunity to buy, hold and sell any other type of asset.”

But all banks could consider how to educate their customers, many of whom are likely trading cryptocurrencies even if it’s not happening in the bank. “Help those customers with things like tax implications … or understanding how crypto may or may not fit into things that their retail customers are interested in. That’s one of the things that financial institutions could do right now that would be good for their customers,” says Wester. “There’s a real need for education on the part of consumers about [this] financial services product.”

Fed Account Guidance Yields More Confusion

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In seeking answers from the Federal Reserve Board and one of the regional banks, a crypto fintech’s lawsuit may have forced the regulator to issue guidance on how other companies can gain access to the nation’s vaunted payment rails. 

At issue are which companies are eligible to request master accounts at the 12 Federal Reserve Banks, and in turn, how the Reserve Banks should consider those requests. Central to this debate — and the timing of this guidance — is the Custodia lawsuit.

The day after the Board released the guidance, it asked a judge to dismiss a lawsuit from Custodia, a company that holds a special purpose depository institutions charter from the Wyoming Department of Banking. Custodia, which focuses on digital asset banking, custody and payment solutions, applied for a master account from the Federal Reserve Bank of Kansas City in October 2020, and sued both the Kansas City Fed and the Board this year to force a decision; the Board cited the final guidelines in its justifications for a dismissal. 

“Honestly, it makes the guidelines seem like they were written, in part, to get courts to give [the Board] more deference when it winds up in litigation,” says Julie Hill, a law professor at the University of Alabama who has written about Fed account access. 

Outside of the lawsuit, the guidance speaks to the interest that fintechs and companies with novel bank charters have shown in opening Fed accounts. A Fed account comes with access to the payment rails; the entire banking as a service (BaaS) business line is premised on banks serving as intermediaries and account holders for fintechs to send and store customer money. 

If the path to applying for a master account becomes clearer, institutions with novel banking charters could bypass bank partnerships, and request and operate these accounts directly. But experts tell Bank Director that the Aug. 15 guidance codifies existing practices while offering little insight into how nonbanks can get these accounts — leaving most fintechs and bank partners where they started. 

Companies that want Fed accounts request access from one of the 12 Reserve Banks, depending on which district the company is located in. The final guidance that the Federal Reserve Board issued is directed to those Reserve Banks; its involvement in these regional banks’ decision-making indicates that the Board is trying make these decisions consistent across regions and may be involved in individual requests as well, experts say.

The Fed’s guidance includes six principles that the regional Reserve Banks should use when evaluating these requests, along with a three-tiered review framework for the amount of due diligence and scrutiny that the Reserve Banks should apply to requests submitted by different types of institutions. 

But observers still see shortcomings in the guidance. Several experts pointed out that the guidance doesn’t address which companies are eligible to apply, which is the first hurdle nonbanks must address before requesting an account. It was one of the most frequently asked questions that companies submitted to the regulator, says Matthew Bisanz, a partner in Mayer Brown’s financial services regulatory and enforcement practice. 

The guidance retains the “substantial discretion” that Reserve Banks have in deciding approvals, meaning that institutions still do not have a clear path to account access, according to a Mayer Brown client note. The process is so unclear that these accounts are granted via requests rather than applications that regulators would normally employ, Hill points out.

Observers are waiting to see how the guidance figures into the Custodia case. Hill says that Custodia is an interesting test case; the company is in a strong position to request an account and addresses many of the regulator’s stated risk concerns. It has an ABA routing number and applied to become a member of the Kansas City Fed, which could advance it from tier three to tier two in the review framework. The company also accepts U.S. dollar deposits but does not have FDIC deposit insurance, which is one factor in the tier one considerations.

What’s Next
Hill says the next step for the Reserve Banks is potentially getting together to develop a sort of operating procedure, which could make the request and decision-making process more consistent across regions. And fintechs that might be interested in a novel bank charter may want to reach out to sympathetic lawmakers in Congress and explain their cause. Custodia and other crypto companies have found a champion in Sen. Cynthia Lummis, R-Wyo., and an ally in Sen. Pat Toomey, R-Pa., both of whom have raised concerns with the Fed and could author legislation that is more accommodative to novel banking charters that the Fed would need to follow. 

In the meantime, companies that want a Fed account and aren’t interested in becoming bank holding companies or partnering with a BaaS bank may find themselves in limbo for a while. Bisanz points out that in litigation, the Fed cited a case that said delays of three to five years are not unreasonable; Custodia brought its lawsuit to expedite a decision. For novel banks, waiting years for a decision may as well mean the death of a business model. 

“There is no guarantee of an application under these guidelines, and there is no guarantee of a decision,” Bisanz says. “Nothing in these guidelines says that the Reserve Banks will act expeditiously. People should read the guidelines, consider applying — but also be ready to sit tight.”

Is Crypto the Future of Money?

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Regardless of their involvement in the financial services industry, anyone paying attention to the news lately will know that cryptocurrencies are making headlines.

As the worldwide economy becomes less predictable, regulatory agencies are wondering whether cryptocurrencies could be used to transfer money if other assets become subject to international sanctions, likening crypto to gold. According to an early March article from CNN Business, the price of gold has spiked and could surpass its all-time high before long, while bitcoin is trading 4% higher.

Crypto has also been in the news because of an executive order recently issued by President Joe Biden. The order requires the Department of the Treasury, the Department of Commerce and other agencies to look into and report on the “future of money,” specifically relating to cryptocurrencies.

As part of that order, those agencies need to outline the benefits and risks of creating a central bank digital currency (CBDC), informally known as the digital dollar. The digital dollar can be thought of as the Federal Reserve’s answer to crypto. It would act like cryptocurrency, with one big difference: It would be issued and regulated by the Fed.

How would this work? One idea involves government-issued digital wallets to store digital dollars. While the U.S. is not likely to take imminent action on creating a CBDC — Congress would need to approve it — it would not be a big leap to sell this concept to the American public. The Federal Reserve reports that cash use accounted for just 19% of transactions in 2021. Digital payments, meanwhile, are up. According to McKinsey’s 2021 Digital Payments Consumer Survey, 82% of Americans used digital payments last year, which includes paying for purchases from a digital wallet like Apple Pay. Using digital dollars, in a similar kind of digital wallet, wouldn’t be all that different. The future state of digital currency and the current state of online payments, credit cards, buy now, pay later purchases and more are, in effect, exchanging bills and notes for 1s and 0s.

What this means for financial institutions is a need to focus on education and information, and an ear toward new regulations.

Educating account holders will be vital. Pew Research reports that 86% of Americans are familiar with cryptocurrencies, while 16% say they have invested. The reason more people haven’t invested? They don’t fully understand it. This is a huge growth opportunity for banks to partner with account holders as a trusted voice of information, within the confines of current regulations.

  • Use account holder transaction data to spot trends in cryptocurrency purchases within their ecosystem and inform them on how to communicate and educate account holders.
  • Task an employee to become the in-house cryptocurrency expert, in the ins and outs of crypto’s current and future state.
  • Develop a section on the website with information for account holders.
  • Create an email campaign that shows account holders a history of investment product adoption with links back to the bank’s website for resources about the latest news on cryptocurrencies. Even if the institution doesn’t facilitate sales, it is important to set the institution up as a trusted resource for industry data.

Crypto fraud is rampant because the majority of people still aren’t quite sure how crypto works. That’s why it’s so important for financial institutions to be the source of truth for their account holders.

Further, fintech is already in the crypto arena. Ally Bank, Revolut, Chime and others are working with their account holders to help facilitate crypto transactions. And even established institutions like U.S. Bank are offering cryptocurrency custody services.

Data will be an important key. Pew Research reveals that 43% of men ages 18 to 29 have invested in, traded or used a cryptocurrency. But what does that mean for your specific account holders? Look closely at spending data with a focus on crypto transactions; it’s an extremely useful metric to use for planning for future service offerings.

The role that traditional financial institutions will play in the cryptocurrency market is, admittedly, ill-defined right now. Many personal bankers and financial advisors feel hamstrung by fiduciary responsibilities and won’t even discuss it. But U.S. banking regulators are working to clarify matters, and exploring CBDC, in 2022.

Is cryptocurrency the future of money? Will a digital dollar overtake it? It’s too early to tell. But all signs point to the wisdom of banks developing a crypto and CBDC strategy now.

Top 5 Fintech Trends, Now and in the Future

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A version of this article originally appeared on RSM US LLP’s The Real Economy Blog.

Financial technology, or fintech, is rapidly evolving financial services, creating a new infrastructure and platforms for the industry’s next generation. Much remains to be seen, but here are the top trends we expect to shape fintech this year and beyond:

1. Embedded Finance is Here to Stay
Increasingly, customers are demanding access to products and services that are embedded in one centralized location, pushing companies to provide financial services products through partnerships and white-label programs.

Health care, consumer products, technology companies can embed a loan, a checking account, a line of credit or a payment option into their business model and platform. This means large-scale ecosystem disruption for many players and presents a potential opportunity for companies that offer customized customer experiences. This also means the possibility of offering distinct groups personalized services uniquely tailored to their financial situation.

2. A Super App to Rule All
We also anticipate the rise of “super apps” that pull together many apps with different functions into one ecosystem. For example, WeChat is used in Asia for messaging, payments, restaurant orders, shopping and even booking doctors’ appointments.

The adoption of super apps has been slower in the United States, but finance and payment companies and apps including PayPal Holding’s PayPal and Venmo, Block’s Cash App, Coinbase Global’s cryptocurrency wallet, Robinhood Markets’ trading app, buy now, pay later firms Affirm and Klarna and neobank Chime are building out their functionality. Typical functions of these super apps include payments via QR code, peer-to-peer transfers, debit and checking accounts, direct deposits, stock trading, crypto trading and more.

3. DeFi Gains Further Acceptance
Roughly a third of all the venture capital fintech investments raised in 2021 went to fund blockchain and cryptocurrency projects, according to PitchBook data. This includes $1.9 billion in investments for decentralized finance (known as DeFi) platforms, according to data from The Block. DeFi has the potential not only to disrupt the financial services industry but radically transform it, via the massive structural changes it could bring.

DeFi is an alternative to the current financial system and relies on blockchain technology; it is open and global with no central governing body. Most current DeFi projects use the Ethereum network and various cryptocurrencies. Users can trade, lend, borrow and exchange assets directly with each other over decentralized apps, instead of relying on an intermediary. The net value locked in DeFi protocols, according to The Block, grew from $16 billion in 2020 to $101.4 billion in 2021 in November 2021, demonstrating its potential.

4. Digital Wallets
Digital wallets such as Apple Pay and Google Pay are increasingly popular alternatives to cash and card payments, and we expect this trend to continue. Digital wallets are used for 45% of e-commerce and mobile transactions, according to Bloomberg, but their use accounts for just 26% of physical point-of-sale payments. By 2024, WorldPay expects 33% of in-person payments globally to be made using digital wallets, while the use of cash is expected to fall to 13% from 21% in the next three to four years.

We are starting to see countries like China, Mexico and the United States strongly considering issuing digital currency, which could also drastically reduce the use of cash.

5. Regulators Catching Up to Fintechs
It’s no surprise that regulators have been playing catch up to fintech innovation for a few years now, but 2022 could be the year they make some headway. The Consumer Finance Protection Bureau, noting the rapid growth of “buy now, pay later” adoption, opened an inquiry into five companies late in 2021 and has signaled its intent to regulate the space.

Securities and Exchange Commission Chair Gary Gensler signaled the agency’s intent to regulate cryptocurrencies during an investor advisory committee meeting in 2021. The acting chair of the Federal Deposit Insurance Corp. has similarly prioritized regulating crypto assets in 2022, noting the risks they pose. And this January, the Acting Comptroller of the Currency, Michael Hsu, noted that crypto has gone mainstream and requires a “coordinated and collaborative regulatory approach.”

Other agencies have also begun evaluating the use of technologies like artificial intelligence and machine learning in financial services.

The Takeaway
There are other forces at play shaping the fintech space, including automation, artificial intelligence, growing attention on environmental, social and governance issues, and workforce challenges. But we’ll be watching these five major trends closely as the year continues.

A Seller’s Perspective on the Return of Bank M&A

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Any thoughts of a lingering impact on mergers and acquisitions as a result of the 2020 economic downturn caused by Covid-19 should be long gone: 2021 bank transaction value exceeded $50 billion for the first time since 2007.

Continued low interest rates on loans and related compression of net interest margin, coupled with limited avenues to park excess liquidity have made many banks consider whether they can provide sustainable returns in the future. Sustainability will become increasingly difficult in the face of continued waves of change: declining branch transactions, increasing cryptocurrency activity and competition from fintechs. Additionally, the fintech role in M&A activity in 2021 cannot be ignored, as its impact is only expected to increase.

Reviewing 2021 M&A transactions, one could argue that the market for bank-to-bank transactions parallels the current residential home market: a finite amount of supply for a large amount of demand. While more houses are being built as quickly as possible, the ability for banks to organically grow loans and deposits is a much slower process; sluggish economic growth has only compounded the problem. Everyone is chasing the same dollars.

As a result, much like the housing market, there are multiple buyers vying for the same institutions and paying multiples that, just a few years ago, would have seemed outlandish. For sellers, while the multiples are high, there is a limit to the amount a buyer is willing to pay. They must consider known short-term gains in exchange for potential long-term returns.

For banks that are not considering an outright sale, this year has also seen a significant uptick in divestures of certain lines of business that were long considered part of the community bank approach to be a “one-stop shop” for customer needs. Banks are piecemeal selling wealth management, trust and insurance services in an attempt to right-size themselves and focus on the growth of core products. However, this approach does not come without its own trade-offs: fee income from these lines of business has been one of the largest components of valuable non-interest income supporting bank profitability recently.

Faced with limited ability to grow their core business, banks must decide if they are willing to stay the course to overcome the waves of change, or accept the favorable multiples they’re offered. Staying the course does not mean putting down an anchor and hoping for calmer waters. Rather, banks must focus on what plans to implement and confront the waves as they come. These plans may include cost cutting measures with a direct financial impact, such as branch closures and workforce reductions, but should entail investments in technology, cybersecurity and other areas where returns may not be quantifiable.

So with the looming changes and significant multiples being offered, one might wonder why haven’t every bank that has been approached by a buyer decides to sell? For one, as much as technology continues to increasingly affect our everyday lives, there is a significant portion of the population that still finds value in areas where technology cannot supplant personal contact. They may no longer go to a branch, but appreciate knowing they have a single point of contact who will pick up the phone when they call with questions. Additionally, many banks have spent years as the backbone of economic development and sustainability in their communities, and feel a sense of pride and responsibility to provide ongoing support.

In the current record-setting pace of M&A activity, you will be hard pressed to not find willing buyers and sellers. The landscape for banks will continue to change. Some banks will attack the change head-on and succeed; some will decide their definition of success is capitalizing on the current returns offered for the brand they have built and exit the market. Both are success stories.

Blockchain and Banking: Opportunities and Risks With Digital Assets

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In the 12 years that have passed since the world’s first Bitcoin transaction, digital payment systems have come a long way. Crypto and digital assets such as Bitcoin, Ethereum and Ripple make the headlines almost daily and account for more than a million transactions every day.

With more customers holding crypto and digital assets, banks can no longer afford to dismiss the crypto trend and must find ways to address those customers’ needs. The potential benefits extend beyond customer retention. Engaging with crypto and digital assets can provide banks with opportunities to reach out to new customers, differentiate themselves from competitors and find new sources of noninterest income.

As the scope of the crypto landscape has expanded, the debate over the banking industry’s place in it has intensified. Because of its historical role as a cornerstone of the broader financial system, many industry leaders contend that the banking sector has a logical role to play in bringing order and stability to the world of crypto transactions.

This contention is bolstered by the advent of stablecoins, which have values pegged to some other asset such as a fiat currency or a commodity. This feature seeks to reduce price volatility and enable more confident valuations so that stablecoins can be treated more like other intangible assets.

Proponents also note that banks clearly are capable of accommodating the crypto trend — just as they adapted to credit card processing, automated clearinghouse transactions and peer-to-peer payment systems.

While the broader industry sorts out its eventual role in the crypto world, individual banks face more immediate decisions about whether and how they should start accommodating crypto and digital assets. Opportunities abound — beginning with the provision of commercial banking services to companies that hold crypto assets or use them as a medium of exchange.

Beyond standard account services, some banks might choose to apply their expertise in payment processing and settlements to enable digital transactions. Banks with strong custody and wealth management operations might expand those services to accommodate crypto investments. Other banks could decide to accept digital assets as loan collateral.

More specialized, technologically demanding applications could prove feasible for some banks. Possible scenarios include providing merchant processing services using crypto assets, operating crypto ATMs and managing crypto reward or cash-back programs and other decentralized finance applications.

Developing Crypto Capabilities

The first step is deciding which of the various opportunities to pursue. Establishing a separate department or division is usually a poor strategy. A better course is to integrate crypto and digital asset capabilities into existing business lines.

Bank leadership teams clearly have an important role to play in guiding such decisions and should make sure that any venture into crypto and digital assets begins with a thorough strategic assessment. The goal is to identify the bank’s existing strengths and build in crypto components rather than forcing crypto capabilities into business lines where the bank might already be struggling.

Once executives identify promising opportunities, another critical early step is determining the best methodology for developing crypto capabilities. Large banks with extensive in-house technology resources might build their own applications, but most community and regional banks might find it more feasible to work with strong technology partners, including targeted fintech companies supporting the banks’ strategic goals

Risk and Compliance Issues

Risk and compliance uncertainty are common concerns underpinning hesitation among banks when it comes to developing crypto capabilities, given that the relevant regulatory, financial reporting, auditing and tax standards are still evolving. Yet banks can successfully mitigate the uncertainty through effective strategic planning and due diligence.

In addition, regulatory and advisory bodies are actively working to clarify the picture. Agencies such as the Office of the Comptroller of the Currency, the Federal Reserve Board and the Securities and Exchange Commission are crafting guidance or comment letters; financial reporting and accounting organizations are developing standards that will aid board members responsible for overseeing compliance.

With fintech businesses and other competitors eager to engage with crypto-oriented customers, banks cannot ignore the potential customer retention, brand enhancement and revenue generating capabilities of crypto and digital assets. By monitoring the evolving guidance and carefully evaluating the risks and opportunities, banks can pursue a balanced approach that capitalizes on the potential benefits while remaining consistent with their established levels of risk tolerance.

2021 Technology Survey Results: Tracking Spending and Strategy at America’s Banks

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JPMorgan Chase & Co. Chairman and CEO Jamie Dimon recognizes the enormous competitive pressures facing the banking industry, particularly from big technology companies and emerging startups.

“The landscape is changing dramatically,” Dimon said at a June 2021 conference, where he described the bank’s growth strategy as “three yards and a cloud of dust” —  a phrase that described football coach Woody Hayes’ penchant for calling running plays that gain just a few yards at a time. Adding technology, along with bankers and branches, will drive revenues at Chase — and also costs. The megabank spends around $11 billion a year on technology. Products recently launched include a digital investing app in 2019, and a buy now, pay later installment loan called “My Chase Plan” in November 2020. It’s also invested in more than 100 fintech companies.

“We think we have [a] huge competitive advantage,” Dimon said, “and huge competition … way beyond anything the banks have seen in the last 50 [to] 75 years.”

Community banks’ spending on technology won’t get within field-goal distance of JPMorgan Chase’s technology spend, but budgets are rising. More than three-quarters of the executives and board members responding to Bank Director’s 2021 Technology Survey, sponsored by CDW, say their technology budget for fiscal year 2021 increased from 2020, at a median of 10%. The survey, conducted in June and July, explores how banks with less than $100 billion in assets leverage their technology investment to respond to competitive threats, along with the adoption of specific technologies.

Those surveyed budgeted an overall median of almost $1.7 million in FY 2021 for technology, which works out to 1% of assets, according to respondents. A median 40% of that budget goes to core systems.

However, smaller banks with less than $500 million in assets are spending more, at a median of 3% of assets. Further, larger banks with more than $1 billion in assets spend more on expertise, in the form of internal staffing and managed services — indicating a widening expertise gap for community banks.

Key Findings

Competitive Concerns
Despite rising competition outside the traditional banking sphere — including digital payment providers such as Square, which launched a small business banking suite shortly after the survey closed in July — respondents say they consider local banks and credit unions (54%), and/or large and superregional banks (45%), to be the greatest competitive threats to their bank.

Digital Evolution Continues
Fifty-four percent of respondents believe their customers prefer to interact through digital channels, compared to 41% who believe their clients prefer face-to-face interactions. Banks continued to ramp up their digital capabilities in the third and fourth quarters of last year and into the first half of 2021, with 41% upgrading or implementing digital deposit account opening, and 30% already offering this capability. More than a third upgraded or implemented digital loan applications, and 27% already had this option in place.

Data Dilemma
One-third upgraded or implemented data analytics capabilities at their bank over the past four quarters, and another third say these capabilities were already in place. However, when asked about their bank’s internal technology expertise, more than half say they’re concerned the bank isn’t effectively using and/or aggregating its data. Less than 20% have a chief data officer on staff, and just 13% employ data scientists.

Cryptocurrency
More than 40% say their bank’s leadership team has discussed cryptocurrency and are weighing the potential opportunities and risks. A quarter don’t expect cryptocurrency to affect their bank; a third haven’t discussed it.

Behind the Times
Thirty-six percent of respondents worry that bank leaders have an inadequate understanding of how emerging technologies could impact their institution. Further, 31% express concern about their reliance on outdated technology.

Serving Digital Natives
Are banks ready to serve younger generations? Just 43% believe their bank effectively serves millennial customers, who are between 25 and 40 years old. But most (57%) believe their banks are taking the right steps with the next generation — Gen Z, the oldest of whom are 24 years old. It’s important that financial institutions start getting this right: More than half of Americans are millennials or younger.

To view the full results of the survey, click here.

How Innovative Banks Capitalize on Cryptocurrency

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This summer, three new developments in the relationship between banks and cryptocurrency players signaled a shift in attitudes toward digital assets.

In May, JPMorgan Chase & Co. began providing banking services to leading crypto exchanges Coinbase and Gemini Trust Co., — a notable change given that Chairman and CEO Jamie Dimon called the seminal cryptocurrency Bitcoin “a fraud” just three years ago. In July, the acting comptroller for the Office of the Comptroller of the Currency, Brian Brooks — who served as the chief legal officer for Coinbase prior to his appointment — released an interpretation letter confirming that financial institutions can bank cryptocurrency clients and could even serve as digital asset custodians. And this month, the popular crypto exchange Kraken secured a special purpose banking charter in Wyoming, marking the first time a crypto company gained banking powers, including direct access to payment rails.

Cryptocurrency is gaining wider acceptance as a legitimate commercial enterprise. But, like other money services businesses, these companies still find it difficult to obtain basic banking services. This is despite the fact that crypto is becoming more mainstream among consumers and in the financial markets. The industry is booming with a market capitalization equivalent to over $330 billion, according to CoinMarketCap, but it’s currently served by just a handful of banks.

The best-known institutions playing in the cryptocurrency space are New York-based Signature Bank and Silvergate Capital Corp., the parent company of La Jolla, California-based Silvergate Bank.

Signature’s CEO Joseph DePaolo confirmed in the company’s second-quarter earnings call that $1 billion of the bank’s deposits in quarter came from digital asset customers. And at just $1.9 billion in total assets, Silvergate Bank earned over $2.3 million in fees in the second quarter from its crypto-related clients. These gains weren’t from the activity taking place on the banks’ respective payment platforms. They came from typical commercial banking services — providing solutions for deposits, cash management and foreign exchange.

One community bank hoping to realize similar benefits from banking crypto businesses is Provident Bancorp. The $1.4 billion asset institution based in Amesbury, Massachusetts, which recently rebranded as BankProv, aims to treat crypto companies as it would any other legal commercial customer. Crypto customers may have heightened technology expectations compared to other clients, and present heightened compliance burdens for their banks. But the way CEO David Mansfield sees it, these are all things BankProv needs to address anyway.

“It really pushes traditional, mainstream corporate banking to the next level,” he explains, “so it fits with some of our other strategic goals being a commercially focused bank.”

Before BankProv launched its digital asset offering, it did a lot of groundwork.

The bank revamped its entire Bank Secrecy Act program, bringing in experts to help rewrite procedures and new technology partners like CipherTrace to provide blockchain analytics and transaction monitoring. It retooled its ACH offerings, establishing a direct connection with the Federal Reserve and expanding its timeframe for processing transactions to better serve clients on the West coast. And BankProv’s team met with crypto-related businesses for insights about what they wanted in a bank partner, which led the bank to upgrade its API capabilities. BankProv is working with San-Francisco-based fintech Treasury Prime to make it possible for crypto clients to initiate transactions directly, instead of going through an online banking portal.

At the same time, BankProv made plans for handling the new deposits generated by the business line; crypto-related companies often experience more volatility in market fluctuations than typical commercial clients.

“It’s definitely top of the regulator’s mind that they don’t want to see you using these funds to do long-term lending,” Mansfield says.

For BankProv, part of managing these deposits is deploying them toward the bank’s mortgage warehouse lending business; those loans are short-term, maturing within seven to 15 days. “[Y]ou need to find a good match on the asset side,” Mansfield explains, “because just having [deposits] sit in Fed funds at 10 basis points doesn’t do you much [good] right now.”

While BankProv officially announced that it would begin servicing digital asset customers in July 2019, the onset of Covid-19 made it difficult to get the program into full swing until recently. With travel being severely limited, BankProv made it a priority to hire new business development talent earlier this month that came with a pre-existing Rolodex of crypto contacts. The digital asset business hasn’t appeared in the company’s 2020 earnings releases so far.

Banking crypto-related clients will only make sense for some of the most forward-thinking banks; but for those that are successful in the space, the upside is significant. Mansfield believes BankProv has the attributes needed to thrive as a part of the crypto community.

“You have to be open minded and a little innovative. [I]t’s certainly not going to be right for the vast majority of banks,” he says, “and I think that’s why there’s really only two that are dominating the space right now. But I feel there’s at least room for a third.”

What Are The Real Risks Of Blockchain?

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blockchain-2-25-19.pngIn the landscape of innovative disruption, the public’s attention is often focused on bitcoin’s impact on financing and investment options. However, it is important to understand that blockchain, the underlying technology often conflated with bitcoin, carries an even greater potential to disrupt many industries worldwide.

The attraction of blockchain technology is its promise to provide an immutable digital ledger of transactions. As such, it is this underlying technology—an open, distributed ledger—that makes monetary and other transactions work.

These transactions can include bitcoin, but they may also include records of ownership, marriage certificates and other instances where the order and permanence of the transaction is important. A blockchain is a secure, permanent record of each transaction that cannot be reversed.

But with all the positive hype about its potential implications, what are the risks to banks?

The Risk With Fintech
One of the most disruptive effects of blockchain will be in financial services. Between building cryptocurrency exchanges and writing digital assets to a blockchain, the innovation that is occurring today will have a lasting effect on the industry.

One of the principles of blockchain technology is the removal of intermediaries. In fintech, the primary intermediary is a bank or other financially regulated entity. If blockchain becomes used widely, that could pose a risk for banks because the regulatory body that works to protect the consumer with regulatory requirements is taken out of the equation.

This disintermediation has a dramatic effect on how fintech companies build their products, and ultimately requires them to take on a greater regulatory burden.

The Risk With Compliance
The first regulatory burden to consider concerns an often-forgotten practice that banks perform on a daily basis known as KYC, or Know Your Customer. Every bank must follow anti-money laundering (AML) laws and regulations to help limit the risk of being conduits to launder money or fund terrorism.

Remove the bank intermediary, however, and this important process now must occur before allowing customers to use the platform.

While some banks may choose to outsource this to a third party, it is critical to remember that while a third party can perform the process, the institution still owns the risk.

There are a myriad of regulations that should be considered as the technology is designed. The General Data Protection Regulation (GDPR), the European Union’s online privacy law, is a good example of how regulations apply differently on a blockchain.

One of the GDPR rules is the so-called right to be forgotten. Since transactions are immutable and cannot be erased or edited, companies need to ensure that data they write to a blockchain doesn’t violate these regulatory frameworks.

Finally, while blockchains are sometimes considered “self-auditing,” that does not mean the role of an auditor disappears.

For example, revenue recorded on a blockchain can support a financial statement or balance sheet audit. While there is assurance that the number recorded has not been modified, auditors still need to understand and validate how revenue is recognized.

What’s Ahead
The use of blockchain technology has the potential to generate great disruption in the marketplace. Successful implementation will come to those who consider the risks up front while embracing the existing regulatory framework.

There has already been massive innovation, and this is only the beginning of a massive journey of change.

How And Where Blockchain Fits in Traditional Banking

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blockchain-12-26-18.pngMany banks haven’t found an efficient way to deal with issues like payment clearing inefficiencies, consumer fraud, and the general limitations of fiat currencies.

Blockchain, however, may be the go-to solution for many of these challenges.

Issues Traditional Banks Face Today
Traditional banks and financial institutions have faced some challenges for decades, but we have yet to see the technical innovations to mitigate or eliminate them, including inefficient payment clearing processes, fraud and currency options.

Inefficient Payment Clearing Processes
One of the biggest roadblocks that banks face today is how to quickly clear payments while complying with regulatory procedures. The number of payment clearing options available in 2018, is not different from the options available in 2008 – a decade ago.

In the U.S., for example, same-day ACH is likely considered to be the biggest improvement during this decade. Only in recent years have cross-border fintech applications emerged that reduce payment clearing costs and wait times. For the most part, we are still stuck with old architectures that lack innovation, efficiency and the data to make a meaningful impact on money laundering and fraud reduction.

Inability to Stop Fraud
Fraud has always been notoriously difficult to stop. Unfortunately, this remains the case even today. Fraud costs are so high in the US, that interchange fees paid by merchants are some of the highest in the world. Despite an increase of available identity fraud detection systems, banks are still unable to make a material improvement in fraud reduction.

For banks, this leads to financial losses in cases where funds are paid to the fraud victim. For customers, this can reduce trust in the bank. For merchants, it means higher fees for facilities, which creates higher costs for customers. Additionally, customers often wait to receive a new bank card. In 2017 alone, the cost the data lost to identity theft totaled $16.8 billion.

Limited Number of Currency Options
Fiat currencies are limited by geography and slim competition.

When we think about fiat currency around the globe, we have seen a steady move towards standardization. This presents risks for banks and consumers. For example, a heavy reliance upon a single national currency relies upon factors like economic growth and monetary policy.

Twenty-eight nations have experienced hyperinflation during the past 25 years. Not only did banks fail in some cases, but entire economies collapsed. Because there were no currency choices, the problem could not be easily avoided.

This process continues to happen in many locations globally.

Benefits of Blockchain Over Traditional Systems
There are ways blockchain can reduce or eliminate these issues for financial institutions.

More Efficient Approval Systems
When compared to traditional payment approval processes, many blockchains are already more efficient. Instead of waiting days for payments to go through clearinghouses, a well-designed blockchain can complete the verification process in minutes or seconds. More importantly, blockchain also offers a more transparent and immutable option.

With innovations like KYC (Know Your Customer) and KYT (Know Your Transaction) transactions conducted via blockchain, banks can be more capable of preventing finance-related crimes. This means traditional finance can more effectively comply with laws for AML (Anti-Money Laundering), ATF and more.

In addition, legitimate transactions can be approved at a lower cost.

No More Fraud
While fraud seems like a pervasive issue in society, this can be reduced using technology. Blockchain can change how people prove identity and access services.

Instead of having to wait to stop a case of fraud, blockchain can stop transactions before they ever occur. The Ivy Network will have smart contracts which will allow banks and financial institutions to review a transaction and supporting KYC and KYT before accepting the deposit. Because blockchain transactions are immutable, we could see a reduction in counterfeiting of paper currency and consumer products.

Increased Digital Payment Options
While blockchain has many use cases, this is one example of how technology can change finance and the global economy. In the early days of cryptocurrency, there was really only bitcoin. Now, there is a range of coins and tokens like Ivy that serve important purposes within existing regulatory and legislative frameworks.

One of the biggest misconceptions is crypto and fiat payment systems have to be direct competitors. By creating a blockchain protocol that links fiat and cryptocurrency, businesses and consumers can have more, better market choices and use cases for cryptocurrency.

At the same time, financial institutions can serve an important role in the future of digital payments and fiat-crypto currency conversions.

As financial institutions look to solve many challenges they face around payment clearing inefficiencies, consumer fraud, and the limitations of fiat currencies, blockchain is a viable solution. Financial institutions that fail to embrace blockchain’s potential will face heightened monetary and reputational risks, and miss opportunities for growth and innovation.