BANKING CRISIS - PART 4 - Fall of Silvergate Bank

Silvergate Bank, established in 1988 as a bank in California, ventured into serving cryptocurrency users in 2016 and went public with an initial public offering in 2019.  

Silvergate Capital Corporation, the parent company of Silvergate Bank, announced its intention to wind down operations and voluntarily liquidate the bank, which faced financial difficulties due to the "crypto winter" and the collapse of FTX. 

What happened?

• Silvergate Bank, initially a savings and loan association, transformed into a bank in 1996 and operated as a community bank in San Diego. Later the bank served cryptocurrency clients and experienced rapid growth, conducting an IPO during a cryptocurrency bubble. 
• It operated the Silvergate Exchange Network (SEN), facilitating fiat-to-crypto exchanges. Following the FTX bankruptcy they shut it down as a way to reduce their risk exposure as it was "less than well capitalized" which caused worry in an already turmoil crypto market and created a mass exodus of clients.
• Political pressure, loan repayment demands, delayed reports, and the FDIC's first US bank failure since 2020 did not help Silvergate. The bank incurred substantial losses from selling assets below market value, and a Justice Department investigation added to its troubles.
• Ongoing regulatory inquiries led to record withdrawal - more than $8bn in deposits which led to Silvergate reporting a $1bn loss and stock declining by over 40%.
• Silvergate capital eventually winded down its operations and voluntarily liquidated its bank. Their stock is down by 99% from its peak.

Additionally weak banking regulations.

• Current banking regulations, including minimum equity-asset ratios, were insufficient to prevent these failures, and changes made in 2018 weakened regulatory requirements for smaller banks. 
• Insufficient bank equity was a key factor in these developments, as higher equity levels would have allowed banks to sell assets and repay creditors with losses borne by bank owners. 
• The establishment of the Federal Reserve's bank term lending facility acknowledges the problem of inadequate equity in banks, providing a means for banks to sell assets at par value. 
• Banking regulation aims to reduce individual bank failures and systemic rescues, but current regulations have proven inadequate. 
• Regulatory changes in 2018 weakened stress testing, risk management, liquidity, and resolution planning requirements for smaller banks. 

What could have been done in hindsight?

• Regulatory pressure, concentration risks, and limited banking options for specific sectors contributed to Silvergate's downfall. 
• Management's decision to allocate the bank's funding heavily towards the cryptocurrency business played a role in their troubles. Hindsight suggests they could have diversified funding sources or exercised more conservative fund deployment. 
• The management team had excessive exposure to interest rate risk. They held bonds that declined in value as interest rates rose and had clients engaged in an asset class highly sensitive to interest rates. Their business was vulnerable to market shifts due to its dependence on the rate cycle. 
• The management team paid 0% on deposits and even received payments to move funds, which made them overly reliant on a risky strategy. Holding safer assets like T-bills could have been less profitable but more secure. 
• Regulators share some responsibility for the bank's downfall. They have been slow in defining a suitable framework for the cryptocurrency industry, leaving banks like Silvergate in a challenging position. Many regulatory agencies seem more focused on expanding their jurisdiction over crypto than understanding the asset and its proper business practices. 
• In the end, the depositors were made whole, they avoided taking the FDIC insurance fund or any government bailout. It was the shareholders that took the hit, not the depositors or the government – which in a way, was the ideal scenario for a bank collapse.
• The challenges faced by Silvergate Bank highlighted the risks inherent in traditional banking, such as lack of diversification, aggressive growth strategies, mismatches in maturity amid rising interest rates, and sensitivity to liquidity risk. When these risks are not adequately managed, they can contribute to negative outcomes.  

For investing with a focus on risk management signup for our waitlist at saay.finance/waitlist or read our blogs at saay.finance/blog.