What Happens When Banks Fail? Lessons For Regional Centers

Recent headlines around several regional banks present an opportunity to revisit your approach to escrow administration

by Jill Jones, General Counsel, JTC Americas

The financial world was surprised by the collapse of Silicon Valley Bank (SVB), the second-largest failure of a financial institution in US history. This came after the announcement of the liquidation of Silvergate, and caused concern for further ripple effects throughout the industry. Just a few days later, Federal regulators stepped in to take over Signature Bank in an attempt to calm markets.

We don’t know yet the extent to which these developments will affect the financial sector as a whole, but these banks were dealing with similar issues. Both Silvergate and Signature had accepted significant deposits from crypto companies, and Silicon Valley Bank was a go-to for startups in the tech industry. SVB was heavily leveraged into US Government bonds which were purchased when interest rates were near zero.

After multiple significant interest rate increases by the Federal Reserve in 2022, the value of those bonds dropped. SVB was forced to begin to sell off assets at a loss to cover deposits, sparking worries among its clientele. This resulted in a run on the bank from startups nervous about the current economic situation and their own financial situations. SVB did not have the cash reserves to meet demand, causing regulators to step in. While Signature Bank executives claimed they were still solvent, nonetheless nervous depositors still rushed to withdraw over $10 billion in deposits forcing regulators to step in and vow to protect customers’ deposits at both banks, even those beyond FDIC insurance limits.

These were all regional commercial banks entrenched in technology industries. All were affected both by legislation that raised the threshold for stress testing and by Fed rate hikes, but they also had something else in common: these are the exact kinds of banks that are often used for specialized market segments. While crypto was a common specialty market segment, Signature Bank was also active in the EB-5 space. Why is that, and does this recent news spell trouble for EB-5 investors and Regional Centers?

What kinds of banks are most useful in EB-5?

Despite their dominance in certain sectors, the average American likely wasn’t familiar with SVB or Signature prior to this past month. Given that EB-5 involves investors from around the world, one might expect large, global institutions to be the standard banking partners for EB-5 projects. In reality, the largest banks have no appetite for such niche products. The regional and super-regional banks dominate the space because they have the bandwidth to understand the EB-5 program and appreciate the value such programs bring to their local communities.

That’s why the best EB-5 banking partners are smaller banks that specialize in these types of transactions and account structures. They understand EB-5 and have designed compliance programs to properly manage it. EB-5 makes up an important part of their portfolio. But given that banks of the regional and super regional size are the very type that have recently run into trouble, how does one balance the risk and continue to do business?

Deposit flexibility and the independent escrow agent

It is nothing new to hear that certain bank policies can complicate the raising of capital in an EB-5 offering or that banks who used to participate in holding EB-5 funds decide to exit the space. But the potential loss of funds on deposit was far from mind until this past week and it could have been catastrophic for projects and investors. These ideas highlight the need to have security of the funds and the flexibility to pivot when things change.

Traditionally, groups raising capital from EB-5 investors would go to a bank and request them to open an escrow account, and it would be assumed that the bank would also act as the escrow agent. It would also be expected that the securities offering documents would name that bank as escrow agent. All of this leads to the funds being tied to a single financial institution with balances that far exceed the limits of standard federal deposit insurance limits.

Achieving the desired security and flexibility means separating the role of the escrow agent from the depository bank(s). An independent escrow agent, with proper licensing or charters to provide services nationwide, would have the ability to deposit the EB-5 funds in one or more financial institutions and the freedom to move them as and when needed. That said, it is still vitally important for the independent escrow agent to be well versed in the nuances of EB-5 and especially how to navigate the concerns of financial institutions’ risk and compliance departments. The independent escrow agent would still be limited to banks who are willing to accept EB-5 funds, but at least they would not be restricted to only one.

The ultimate security comes from the independent escrow agent’s ability to diversify risk, and in some cases allocate the funds in such a way that 100% of the deposit can be FDIC insured. The right escrow agent, with the right relationships would be able to structure the accounts in certain ways and then spread the deposits over multiple institutions to avoid having all eggs in one basket, and take full advantage of the insurance coverage available.

How the right EB-5 administrator can help

It’s essential to select a fund administrator who understands EB-5 inside and out, specifically the new rules coming from the Reform and Integrity Act of 2022, including the use of separate insured accounts, the need for co-signatory by the fund administrator on disbursements, and ensuring that the movement of funds is in accordance with the offering documents.

The best choice is a fund administrator that offers comprehensive solutions that are designed to create a culture of security, transparency, and compliance throughout the EB-5 process while also offering peace of mind to investors through purpose-built technology and online access to account and project information. When selecting banking partners, the administrator must ensure it has the flexibility to act when called upon and has procedures in place to accommodate unforeseen situations. The potential consequences, if something goes wrong, are too high.

As recent headlines have shown, it’s impossible to predict when chaos may hit the banking sector, but Regional Centers can protect themselves and their investors with a commitment to best practices that go beyond the minimum required for regulatory compliance and instead seek to provide the utmost in security for investor funds.


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