Minibubbles in U.S. Banking Are Popping

(Bloomberg). A bank from the New England countryside that dates back two centuries suddenly became one the most popular stocks in US finance after it made an unusual proclamation, namely that it was willing to support cryptocurrency ventures.

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Provident Bancorp Inc.’s first chairman was a soldier under George Washington during the Revolutionary War. The stock soared 140% in 14 month as Bitcoin surged towards a record high of November 2021. But as crypto prices fell and took down the FTX exchange last year, Provident’s stock plunged, ultimately going lower than where it started.

The bank’s market value has declined by about two-thirds since the peak, erasing more than $230 million.

They are called minibubbles. There is a trend in the US financial market where small lenders are investing in crypto and other hot areas, which has sent their stock prices soaring before eventually plummeting. It’s played out with online lending, commercial real estate and even taxi medallions over the past several years.

In recent years, the number of lenders being stung continued to rise. Some industry veterans were confused by the willingness for so many bankers not to follow long-standing rules against taking concentrated risks out of a single or unproven source.

“Areas that skyrocket all of a sudden are, almost by definition, going to come back to Earth, and have outsize risk and very little likelihood of consistent reward,” Gene Ludwig, who was the currency comptroller for President Bill Clinton, said this. “Finance of any sort is a potential fire and that conflagration can get roaring pretty quick.”

Signature Bank Inc. and Customers Bancorp Inc. were once popular for their ventures into crypto-related businesses lines. However, they have been trying to soothe shareholders’ concerns in recent months.

Silvergate Capital Corp., another bank that flew higher, suffered one of its most dramatic falls yet. In just hours, it had lost nearly half of its market capital.

Silvergate had received deposits of approximately $12 billion from cryptocurrency ventures. The money was used to make a profit, investing it in securities. That stopped working during FTX’s downfall, when depositors rushed to pull their cash and weather the storm. Silvergate sold its holdings to pay the payouts and tapped wholesale financing, which included $4.3 billion in short-term cash advances at the Federal Home Loan Bank.

The firm’s market capitalization peaked at $5.9 billion in 2021, almost 20 times greater than at the start of 2020. That was down to $386 million on Wednesday — a dramatic wipeout for shareholders in a bank where annual profits never breached $100 million.

Provident stated that it remains well capitalized in spite of losses on crypto miners’ loans. The Amesbury, Massachusetts-based lender appointed interim replacements last month for its chief executive officers. No response was received to messages seeking comment.

Silvergate has stated it “still believes in the digital-asset industry,” The company is committed to ensuring that the environment remains safe and healthy. “highly liquid balance sheet with a strong capital position.”

Watchdogs’ Warning

As the number of cautionary tales mounting, regulators warned banks this Month not to get too far into digital currencies.

“It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system,” Federal Reserve, Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency issued a joint statement expressing concern over business models that are too focused on crypto-related activities.

Crypto is just one example of an old phenomenon in which a few smaller banks become the preferred bank for a particular business trend. For investors who get in early, the booms offer a rare chance to multiply their money betting on an industry that — when risk-taking is conservative — can draw derisive comparisons to utilities.

Such fortunes can fade quickly.

Signature and Customers both saw their stock prices multiply ahead of Bitcoin’s peak in 2021, only to give up much or all of the gains last year. Metropolitan Commercial Bank announced this month that it will be withdrawing from crypto-related services, which once helped to boost its revenues and deposits.

The upside is that smaller banks can explore new technologies or strategies without harming the larger financial system if it goes wrong. Sydney Menefee, an accounting firm Crowe partner, spoke of the benefits. She was also responsible for overseeing community and mid-sized bank supervision at OCC.

“We need to avoid losses to depositors” and the FDIC’s backstop, she said in an interview. “But the system is set up for the traditional shareholder to take the loss. They get the upside, but they also get the downside.”

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