Four questions, many answers: What banks need to know about Silvergate

Whether the bank’s supervisors — the Federal Reserve and the California Department of Financial Protection and Innovation — used their authority to ensure the safety and soundness of the institution is a debatable question. 

Julie Hill, a University of Alabama law professor who specializes in bank regulation, said that the fact that Silvergate was able to dissolve without broader financial consequences — and at no cost to depositors or the federal government — is proof that supervisors were on top of the situation.

“This is, by and large, a good story for banking supervision,” Hill said. “They let a supervised bank try something new, it didn’t work out perfectly, but now it looks like they’ll have a failure without consequence. All the depositors will get their money back with no loss to the Deposit Insurance Fund.”

But others say the fact that Silvergate found itself in this place to begin with reflects poorly on the bank’s supervisors. Dan Awrey, a Cornell University professor of corporate law and financial regulation, said the outcome raises questions about the supervision of Silvergate, given how concentrated the bank seems to have been in risky, crypto-related activities. 

Awrey also noted that regulators not only let the bank incorporate Federal Home Loan bank advances into its capital plan, but also, ultimately, allowed the bank to use them to stave off a bank run spurred by FTX’s collapse.

“I don’t really see any evidence that supervision worked here, especially in the wider view where Silvergate’s business model appears to have been so highly concentrated in crypto and reliant on crypto-related deposits and yet was still able to tap liquidity from the FHLB System,” he said.

Still, Awrey said the unwinding of Silvergate has been “remarkably smooth.” Whether regulators had a hand in that process, it appears to have been the right course of action. 

“If it works, it’s not a bad outcome,” he said.

In public remarks on crypto regulation Thursday, Fed Vice Chair for Supervision Michael Barr (pictured above) said liquidity risks and concentration have been the two of the pillars for the central bank’s approach to crypto supervision. 

Barr did not address Silvergate directly, but he said the Fed has attempted to educate banks about these risks related to crypto, pointing to public guidance issued alongside the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency in recent weeks. He also noted that the onus of managing these risks, particularly in smaller banks, falls on the banks themselves.

“We tend to have a very light touch approach to smaller institutions,” he said. “And so there’s more of an impetus on them to actually be paying attention to these new and novel risks, and we need to make sure that they understand them.”

Todd Phillips, an independent consultant and former FDIC lawyer, said the risks and concentrations of crypto-related deposits and assets on Silvergate’s balance sheet should have been flagged by the Fed or California’s DFPI. Yet, he said, it’s difficult to render a verdict about the efficacy of the state and federal supervisors without knowing what conversations and actions occurred behind the scenes.

“It’s an opaque process, and it’s difficult for us outside the bank to have a really good idea of what happened,” Phillips said, noting that an outside review of what transpired could be in order once the bank is fully dissolved. 

Hill said the Silvergate episode can now serve as a learning experience for both banks and supervisors, to realize what works and what does not, both from a business and supervisory perspective.

She said the debate about whether Silvergate’s unwinding should be celebrated by supervisors ultimately hinges on whether one believes their job is to make banks as risk-averse as possible, or if they should make sure risks taken by banks do not have broader consequences.

“Regulators and banks could take a very conservative approach and say, ‘We’re not going to ever have banks close or ever have bank failures,'” Hill said. “But the danger with that is that you choke off new ideas — not just for business models, but for technology and innovation — and you cut off credit to people whose lives would be improved by it. We don’t need tons and tons of bank failures, but we have lots of banks, so it isn’t the worst thing in the world to have a bank failure every now and then.”

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