Customers Bancorp Inc. could soon close its first loans that use bitcoin or ethereum as part of the collateral for existing institutional customers in digital assets, said Christopher Smalley, head of digital banking at Customers Bank.
The first transactions could close this quarter for the lending product that caters to companies handling digital assets, such as cryptocurrency exchanges and over-the-counter trading desks, as well as hedge funds, Smalley said. They tend to have significant long positions in bitcoin or ethereum, and seek to put them to work by getting loans in fiat currency. With the loans provided by Customers Bank, an over-the-counter desk, for instance, would have more capital to lend to traders and proprietary funds and let them buy on margin on its platform, he said.
Customers Bank currently provides blockchain-backed payments, cash management and checking and savings accounts for digital asset businesses. While few banks currently accept digital assets as collateral for loans, Customers Bank wants to seize the growth opportunity and strengthen the relationships with existing clients in digital assets, Smalley said.
In November, Customers Bank launched Customers Bank Instant Token to convey U.S. dollars between its commercial banking customers as a payment instrument. The blockchain-backed business-to-business payment platform has attracted cryptocurrency businesses to settle payments via Customers Bank.
"It's really an effort for us to collect low-cost deposits in large numbers," said Chief Lending Officer Lyle Cunningham. "So the next logical step for us gathering deposits from that crypto exchange vertical, is really lending into that vertical." As of April 15, total digital asset deposits stood at $2.3 billion, according to the bank's April 28 earnings call.
Among other banks, Goldman Sachs Group Inc. is the latest to join Silvergate Capital Corp., Signature Bank and BankProv to offer loans collateralized by bitcoin. Cryptocurrency companies have also turned to hedge funds and other types of liquidity pools for cryptocurrency collateralized loans, Smalley noted.
How it works
While banks are currently not allowed to hold digital assets on the balance sheet, the cryptocurrency collateral will be placed at third-party custodians. The third-party custodian is responsible for determining the value of the cryptocurrency collateral, using a method that will be contractually stipulated with Customers Bank and the borrower, Smalley said.
Customers Bank will also require the borrowers to use their balance sheet as collateral in addition to the digital assets, Smalley said.
The size of the loans will be well into the millions of dollars, Smalley said. The goal is to provide loans of high dollar value to the leading companies in the digital asset vertical, he said.
Most of the loans will likely be revolving lines of credit, and Customers Bank would conduct a review of the credit every six months. Some of the loans will be term loans, ranging from as little as three days up to 18 months, Smalley said.
The loans and repayments will both be made in fiat currency. Customers Bank sees the possibility in the future that it would make loans in cryptocurrency directly or in a stablecoin, Smalley said.
Customers Bank has kept its regulators informed in a dozen conversations, from when it first had the idea of this product, Cunningham said. As in other lending segments, loans over $20 million will require approval by the bank's credit committee comprised of 10 voting members, he added.
Risk control considerations
Banks that step into bitcoin-collateralized lending will have to prepare risk control measures for the volatile and speculative nature of cryptocurrencies. Bitcoin's price has dropped by 40% year to date.
In addition, since borrowers tend to be in the cryptocurrency business, they carry risks related to market liquidity. It is possible that if the cryptocurrency market were to collapse to the extent that bitcoin was effectively worthless, the borrower's business would likely be worthless as well, Smalley said. It means both forms of collateral, the bitcoin and the borrower's balance sheet, are substantially tied to the value of cryptocurrencies.
In the case of a borrower having liquidity issues with its end customers, the borrower will not be able to pull the digital assets out of the third-party custodial account without Customers Bank's authorization, Smalley said.
To ensure credit reliability, the advance rates will be fairly low, currently targeted to be in the 60% loan-to-value range. Customers Bank will be issuing capital calls constantly, aligned with the trading schedule of the cryptocurrency market, and the cure period will also be short, Smalley said. These measures can help the bank rapidly react to a sharp price drop of bitcoin or ethereum when it needs to liquidate collateral to cure default payments.
"There needs to be a very, very substantial drop in crypto value for us to actually lose any money on the transaction," Smalley said.