This interview originally aired on In the Moment on SDPB Radio.
The unexpected collapse of multiple banks last week exposed some vulnerabilities in the U.S. banking system.
This week, In the Moment has brought you several conversations on what may have contributed to those vulnerabilities and what could come next.
Karl Adam of the South Dakota Bankers Association joins us to discuss the banking system in South Dakota more broadly. Is it safe to keep your money in one of our state's local banks?
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Lori Walsh:
You're listening to In the Moment on South Dakota Public Broadcasting. I'm Lori Walsh. Well, this week we have been exploring the stability and possible vulnerabilities of the banking system. We began on Monday with a financial therapy conversation. On Tuesday, we looked at a decade of low interest rates and fiscal policy and how a so-called age of easy money might contribute to financial vulnerabilities. Yesterday SDPB's Lee Strubinger explained Governor Kristi Noem's veto of what many considered a routine banking regulation update. Today we're going to look more deeply at the banking system in South Dakota. We have Karl Adam with us. He is president of the South Dakota Bankers Association. He is with me on the phone. Karl, thanks for stopping by.
Karl Adam:
Well, thank you, Lori, for having me.
Lori Walsh:
I want to talk about some of this tension about banking stability, but let's start. Just a second. Had to cough there. Let's start with House Bill 1193, which clearly you were able to get lawmakers to understand and pass, but then Governor Noem vetoes it. Was that a surprise to you, first of all, that that would happen to this UCC update?
Karl Adam:
Well, Lori, that's a very good question and I guess for all the bills that the South Dakota Bankers Association worked on and tracked this legislative session, this would've been the last one that we thought would've raised concerns not only with our legislature, across the state and certainly with our governor.
Lori Walsh:
This basically has to do with commercial law and definitions and how things work. Lay out for us how the core values of Bitcoin and cryptocurrency and sort of why this has become a political issue because those core values are antithetical to other core values of what the Federal Bank might do or the central bank might do. But that's kind of separate from what we're actually talking about in the legislation. So explain this with a little air around it so you can really tell people how they should understand this.
Karl Adam:
No, I appreciate that question, Lori. Let me set the stage. So this bill, 1193, is a house bill and it's an act to amend the provisions of the Uniform Commercial Code. Giving you just a real high level overview, the Uniform Commercial Code is state law and it's state law among all of the states in the country, uniformity, and this is something the Uniform Commercial Code does revisions from time to time, and it just so happened that these amendments, they're called the 2022 amendments, to modernize digital assets in the Uniform Commercial Code. It's a modernization bill. Yes, as it was stated in other accounts, it was a lengthy bill, 117 pages, but it's defined around and the revisions and amendments are defined around digital assets.
Now, uniform commercial law, Uniform Commercial Code is something that gives business certainty when conducting business in your state and across state lines. Legal certainty is good for business. It's the invisible backbone for retailers, banks, if you're in egg production, selling livestock across state lines and so forth, you have the defined terms within the UCC that helps provide that legal certainty. What this bill does that has not been defined, as we all recognize in the last decade or so, and even probably longer ago than that, digital assets has not been defined. Businesses across the country and perhaps across the world are transacting business with digital assets. That means, as an example, in other states and maybe areas here in South Dakota, you have the ability to offer Bitcoin or a virtual currency as a means of exchange, or else money.
The concern that the governor had that came out in her veto message was two-pronged. The first point was that she misinterpreted the language to specifically exclude cryptocurrency in the UCC and not define it as money. There is a reason for that. Money is a tangible or an item that you can possess. It wasn't included in the definition of money only for UCC state law purposes. It doesn't change the definition as it relates to the Internal Revenue Service and other things, but only for the purposes of the Uniform Commercial Code. The crypto world or the virtual currency, it's defined as a controllable electronic record. The reason for that is the virtual currency is not able to be possessed. You can't grab it.
Let me give you a couple of examples. If I go to a bank and request money, make an application to buy a car, a bank is able to lend me funds to buy the car and they insert their lien on a Title, a car is titled. They declare their lien on the title and that's how they secure their security interest in that automobile. The same thing would be true if you go to your lender in requested money made application to buy a home. They insert their security interest or their mortgage on a physical mortgage based upon the physical location of that home. What this does with a controllable electronic record, since it's not able to be possessed, again, it's defined as a controllable electronic record or a CER. What this allows those that are looking for the opportunity to use their crypto or Bitcoin as security, that blockchain unique set of numbers that identifies that I own X number of dollars worth of or so many virtual currency coins, I can pledge that as security.
If the bank is willing to do it, they will then have the opportunity by having control of that asset to lend me money and perfect their security interest as I may use that as collateral to buy something.
Lori Walsh:
Okay, so here's my core question. I'm going to jump in here and hopefully this takes us further down the road and not further away from it. If you're the lender or you're my banker, you're my community banker, I want to buy that car, that house or that farmland, and I say, "I own this much Bitcoin, I want to use that as collateral." You say, "Okay," but I want it to remain private because that's the nature of Bitcoin. I don't want someone else to know how much Bitcoin I have. You can't file on it because it's Bitcoin. So help me understand how privacy works on this because if I default, you need to be able to collect that collateral, but you can't really possess it. How does privacy work in this conversation? Because that's core to cryptocurrency.
Karl Adam:
The privacy is paramount and whether you're using cryptocurrency or virtual currency or other means, it's paramount for a financial institution to protect the privacy of that individual in that business transaction. The same privacy concerns would apply here. The individual would know that they are willingly offering this as collateral. The financial institution would willingly accept it and conduct a transaction. The concerns for privacy would remain as if you were doing it with any other form of currency or means of trade.
Lori Walsh:
What if I can't use it for collateral on 10 different loans with 10 different banks though? Is that ...
Karl Adam:
That is correct. What it also does is when you file a UCC, as an example, a Uniform Commercial Code within the code, you're able to see if there's other lien holders. If I were to use equity in my home to borrow against the equity in my home to buy something else, the lender was able to do a UCC search and see that it's in favor of ABC bank and maybe another bank. Then it's encumbered, so therefore there is not the ability to do so or else the lender could take a second position behind the other lender and so forth. This would also give legal standing so that the virtual currency holder recognizes they're willing to provide this as collateral. The bank is able to then identify for certain that this is unencumbered and I'm able to use this as collateral.
Lori Walsh:
So what happens next? Are lawmakers going to override this veto? Because there was one more criticism that the governor mentioned earlier this week, it might have even been yesterday, and that was about the timing. She's like, "This doesn't need to be done until 2024. Let's just take a run at it at the next legislative session." What's your response to that?
Karl Adam:
Well, if I could back up Laurie, and then I'll get to that as I finish the second part of the concern that the governor shared was central bank digital currency. That's the other point. It's known in the banking world as CBDC, central bank digital currency, and that is a defined term also. If we don't look to modernize this new legislation, the 2022 amendments, we will be putting our South Dakotans at a disadvantage. What the CBDC does, and her concern here is the reason it has to be defined, there's two countries as we know it today that have a CBDC, central bank digital currency. They are the Marshall Islands. The Marshall Islands has a CBDC called the SOV, S-O-V and The Bahamas has the sand dollar. Since those two countries have a CBDC and we are in a global marketplace, should they do business here, that has to be identified in the terms.
CBDC is something that the United States government does not have N I want to share the difference. UCC is state law. It is nothing to do with the federal government and the reason we're able to do it at state law is because the UCCS been around for decades and in South Dakota since the early 1960s, and we've done it well, well enough so that uniform state law is the roadmap in the event of dispute arises across state lines and interstate commerce. It's been defined because in the world there are two as we know it, and it's fair to say that the United States government, the United States Department of Treasury has talked about a CBDC, and there is an ongoing working group about CBDC, the good, the bad, and the ugly, and they're working on vetting that as we speak.
It's not to say that the Uniform Commercial Code, the 2022 Amendments House Bill 1193 advances that ball. It doesn't. If that was an issue, that will be an issue with the federal government and we'll take that up at a later discussion, but this does not advance the ball. It's a defined term so that we are able to modernize the code to bring digital assets into the modern world as we continue to transact business not only in South Dakota but across state lines.
Now, as far as the timeframe goes, Lori, the bill already contemplates that it's a July 1 of '24 effective date. I know that there's been folks out there that have said, "Well, why don't we just bring it up next year and try to resolve this?" There is a runway that is needed. When you pass legislation that is sweeping as this, the legal community, the financial community works with their vendors and so forth to put proper disclosures in place, and it takes time, so that when we are transacting business after such a day, July 1 of '24, that we have everything in line. It doesn't indicate if it's passed this year or we're able to override the veto that it's going to go into effect July 1 of this year. Quite the contrary.
What we've argued and shared is if the bill needs to be tweaked, if the Uniform Law Commission, which is kind of the drafter of this uniform law, has other changes, we can bring that up with amendments next year. But we need to help South Dakota be as pro business as we have been in the past and provide the opportunity for business certainty by updating these Uniform Commercial Code this year.
Lori Walsh:
Karl, there are a couple things I want to get to before we run up against our clock here and one of them is just what should South Dakotans be asking their bankers if they have concerns about the security of their deposits in an age where we've seen two banks collapse. Those were unique banks with large percentages of uninsured deposits. So you're in a rural community, you know your banker probably in this state, you call them up. What should your questions be beyond, "Is this going to be okay?"
Karl Adam:
Lori, those are very good questions and not only are we working on the UCC House Bill 1193, but this last week has been rather ... it rattles everybody's confidence what's taken place with the two bank failures in the last week. As you mentioned I think very, very well is we emphasize talk to your bank. Most people in South Dakota know who their banker are by first name. They go to church with them, they've raised their kids together and so forth, and there's a lot of confidence with your local bank, and we think it's very, very important to reach out to the local bank and ask them those important questions. Everybody has the ability, in this day and age, to get 24/7 news and everybody's reading it. I always suggest source what you read, know there's going to be different vents to it, but these two bank failures were extremely unique for a lot of reasons.
But banks in South Dakota overall and the banking system in America should have confidence in our banks. I think it'll go a long way in providing confidence to the customer by talking to your lenders or talking to your banks. If you are fortunate to have deposits in excess of the FDIC insured limits, which we all know is $250,000, there are tools in the toolkit that banks have that can help you have that level of comfort. There's different kinds of exchange programs, one's called Cedars, where banks can essentially act as a broker. If you've got money in excess of the 250 and you want to have it insured, it's a reciprocal program with other banks around the state and around the country that buys additional insurance for your money, or they swap out kind of in a paper transaction the ability to ensure somebody else's money in this institution so that you're comfortable for sleeping purposes and confident in your future, financial future, that your money is well and taken care of.
Lori Walsh:
Are smaller banks in South Dakota seeking support from larger banks?
Karl Adam:
Smaller banks in South Dakota, and the like is true across the country, they have what's called correspondent banking relationships. A lot of our community banks have relationships with other correspondent banks that serve those kinds of utilities that offer asset liability management, offers different types of lending abilities, making sure they can meet liquidity events. That was one of the things that took place with the two failed banks this last week, that they weren't able to liquidate or didn't have the cash on hand without selling off their security portfolio at a discount that caused the run on these banks.
Then overall paranoia, and we all understand it, we all get caught up in it, but we have to talk ourselves off ledge. I think as you mentioned, Lori, the first step in doing so is reaching out to your community bank. They'll be happy or your banks in South Dakota, whomever you bank with, and they'll be happy to provide that level of confidence for you going into the future.
Lori Walsh:
Let's do one more question and then we really have to wrap things up, but Senate Bill 41, which was the Housing Opportunity Fund, South Dakota Bankers Association lobbied for that. It did pass. Help us understand how this $200 million housing infrastructure fund could be impacted by or could intersect with slowing economic growth, a looming recession, the Fed raising rates. Are they going to collide?
Karl Adam:
That's a fair question, and all of this is very fluid, Lori. The housing infrastructure funds started with the task force in 2021 with several legislators in both the Senate and the House, got together with the governor's office to put this together. My recollection, it's a $200 million fund being managed by the South Dakota Housing Development Authority. I think 50 million of it is state funds and $150 million of it is American rescue funds are also known as ARPA, part of the stimulus. It's a very good program to help build infrastructure for career housing across South Dakota.
Now, with the events of the last month or so, does this give rise to concerns for a slowing economy? I think that South Dakota at large has kind of bucked the recession discussion across South Dakota. We've been vibrant. You can see that through our sales tax revenue and other things. I think that this would be at the most a blip in the screen, blip on the radar as we move ahead, but it will be impactful for communities around South Dakota to have the opportunity to tap into these resources, to put the infrastructure in the ground, so things below ground, and it allows financial institutions in South Dakota to then participate in improved or value added lots that can be built for the career housing needs across the state.
Lori Walsh:
All right. We'll have more on that later. Karl Adam is president of the South Dakota Bankers Association. We really appreciate you taking the time to spend, especially so much time, with us talking about this today.
Karl Adam:
Well, Lori, appreciate you reaching out and very important topics and, again, appreciate your time today.
