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The regulatory framework governing the US banking sector is continually changing to accommodate the demands of a dynamic market. Regional banks have recently come under pressure from the Federal Deposit Insurance Corporation (FDIC), essentially for improper management of bond duration, which has reduced liquidity and resulted in the closure of several regional banks. The FDIC is also acting to stop instances of money laundering using cryptocurrencies at several of these institutions, thus there is also a money laundering and cryptocurrency component to the tale.
Mismanagement of bond duration is a problem that is plaguing the regional banking sector. Bond duration is a measure of how sensitive a bond`s price is to a change in interest rates in the broader economy. Banks are subject to interest rate risk when they purchase long-term bonds, which may have a detrimental effect on their liquidity. Bonds lose value as interest rates increase, making it more challenging for banks to sell them for cash. Decreased liquidity as a result of this may eventually result in the bank`s insolvency.
Regional banks have come under the FDIC`s scrutiny for improper management of bond portfolio duration, and as a result, a few banks have been forced to close, most notably Silicon Valley Bank, but also Silvergate Bank and Signature Bank. While only 1.4% of larger banks reported a negative return on assets in 2018, 4.4% of regional banks did. To lessen the effect of interest rate risk on banks` liquidity, the FDIC has been urging banks to switch their securities from available for sale (AFS) to held-to-maturity (HTM), but this decision is best made when the securities are acquired, not mid-stream. Shifting bonds from AFS to HTM or vice versa often entails actually recognizing a loss on the abandoned decision.
Recently, there has been increasing stress on the US regional banking sector. Regulatory constraints, artificially-low interest rates, and greater competition from larger banks are just a few of the difficulties the sector has been dealing with. As a result, it has been difficult for many regional banks to continue to be profitable.
The FDIC reports that since 2010, there have been 42% fewer banks with assets under $1 billion. Combinations of factors, such as mergers and acquisitions, regulatory constraints, and greater competition, are to blame for this reduction. Only 22 new banks were chartered between 2020 and 2022, according to the FDIC, which has also indicated a marked decline over time in the number of new bank charters; in fact, 175 new banks were chartered in 2007. Since 2010, only 48 bank charters have been approved, including zero approvals in some years.
Regional banks are, nonetheless, making adjustments to the evolving regulatory landscape. To compete with bigger banks, they are acquiring new technology and increasing their service offerings. To improve their size and effectiveness, some regional banks are also thinking about combining with other financial institutions.
In order to tighten regulation of the banking sector in response to the Great Financial Crisis of 2008, the Dodd-Frank Financial Regulatory Reform Law was passed in 2010. For the purpose of evaluating the financial stability of banks and averting future financial crises, the bill incorporated a number of additional provisions, such as stress testing and the `living will` provisions of the act which distinguish between systemically-important institutions, and others.
The Dodd-Frank Act`s stress tests have made it easier for regulators to spot banks that may fail. Annual stress tests for banks are mandated to evaluate their resilience to challenging economic situations. The 33 banks that took the stress test in 2022 all passed.
The Dodd-Frank Act`s `living will` provision mandates that banks have a strategy in place to handle their business in the event of bankruptcy. This mandate guarantees that banks have a plan in place to safeguard consumer savings and prevent a bailout.
The FDIC`s investigation into regional banks has also turned up instances of cryptocurrency-based money laundering. Because they are decentralized and anonymous, cryptocurrencies are a common tool for money launderers. Banks, however, are crucial in the fight against money laundering, and in the transmission mechanism between the fiat and crypto economies.
Anti-money laundering (AML) requirements, which include recognizing and disclosing suspicious transactions, must be followed by banks. To identify and stop the use of cryptocurrencies for money laundering, the FDIC has been collaborating with banks. Moreover, the FDIC has been looking into and subsequently shuttering with prejudice banks that have disobeyed or relaxed on AML requirements.
The usage of cryptocurrencies for illegal purposes, such as money laundering, has grown in recent years. The value of cryptocurrency transactions linked to illegal activity surpassed $10 billion in 2020, according to a report by blockchain analytics company Chainalysis, accounting for 1% of all cryptocurrency transactions. The research also discovered that darknet markets were involved in 55% of illegal transactions.
The FDIC has been attempting to detect and prevent the laundering of value through cryptocurrencies. The FDIC sent letters to banks in 2019 to remind them of their AML responsibilities with regard to cryptocurrency. Moreover, instructions on how to recognize and report suspect bitcoin transactions were included in the letters.
FDIC has issued very public penalties for failing to put in place adequate AML procedures. Suspect transactions only increased. The bank had been negligent in properly monitoring and notifying authorities of any suspicious behavior involving high-risk clients, including bitcoin firms. These latest bank shutdowns likely are intended to instill a proper amount of regulatory fear in AML and Compliance officers, in addition to containing risks to entities responsible and cleaning up collateral damage.
The FDIC`s assault on mismanaged bond duration has resulted in the closure of a number of local banks. Yet in order to guarantee the stability of the financial sector, this is a crucial step. In order to stay competitive and profitable as the industry changes, banks must adjust to new rules and market conditions.
As a result of the FDIC`s discovery of cryptocurrency money laundering, it is clear how crucial banks are to deterring financial crime. Banks and regulators can jointly maintain the integrity of the financial system, as can cryptocurrency operators. Banks must be steadfast in spotting and reporting suspicious transactions as the usage of cryptocurrency for illegal purposes increases.
Notwithstanding the substantial difficulties the US regional banking sector is currently facing, there are still chances for banks to adapt and prosper. Regional banks can set themselves up for long-term success in a changing regulatory environment by making investments in new technology, extending their services, and thinking about mergers and acquisitions. In addition, these actions pave the way for legitimate users of cryptocurrencies to expand their use cases, thus helping to deliver on their promise of decentralized, fast and permissionless transaction, but with the added security of not helping criminals to hide the proceeds of ill-gotten gains. This could be the catalyst for the institutional adoption of cryptocurrencies the market has clamored for, or it could have the more harmful effect of funneling banks` deposit bases to ever-larger institutions. Time will tell.