Fed report blames Silvergate collapse on crypto coziness, nepotism

A recent investigation by the Federal Reserve Board of Governors found that Silvergate Bank collapsed because of its overreliance on crypto clients and nepotism, amongst bank leadership and risky deposits. 

The full report wasn’t released because Silvergate is still technically an open institution, which means that “confidential supervisory and trade secret information” are at play.

Commissioned by the Inspector General’s office at the Federal Reserve Board, the summary of the unreleased Sept. 27 report claimed that the underlying problems leading to the bank’s downfall began in 2013. 

It all started when the bank’s senior leadership changed strategy to focus on “customers engaged in crypto activities.” 

Putting all the risk in one industry was precisely the problem, the Fed said. 

Another problem, the Fed pointed out, was the bank’s caliber of deposits.

“Silvergate had significant, multilayered concentration risk: The bank’s deposit accounts were largely funded from companies in one industry, and nearly all deposits were uninsured and noninterest bearing,” the Fed wrote in the summary report.

And the problem with Silvergate’s overreliance on crypto and crypto-adjacent clients became evident when companies in that industry faced a massive downturn throughout November and December of last year, which was triggered in part by FTX going bankrupt. Collectively, hundreds of billions of dollars were erased from crypto markets in the days following FTX’s downward spiral in early November. 

FTX’s demise and Silvergate’s eventual voluntary liquidation in March 2023 are closely linked, especially since Silvergate lost $1 billion in the fourth quarter of 2022.

All of this and more were factors in the crypto bank’s added stress levels, according to the Fed. 

The Fed added that given the growing size of the bank and its evolving strategy in regards to risk, those in charge were simply “ineffective.”

The bank increased its assets from less than $1 billion in 2017 to more than $16 billion at the end of 2021. 

“Silvergate’s board of directors and senior management were ineffective, and the bank’s corporate governance and risk management capabilities did not keep pace with the bank’s rapid growth, increasing complexity and evolving risk profile,” the Fed wrote. 

Nepotism allegations among the senior leadership team also flew in the summary report, which the Fed said had a role in undermining “the effectiveness of the bank’s risk management function.”

Investigators’ ire was also directed at the Federal Reserve Board and the San Francisco Fed, the regional central bank responsible for regulating Silvergate.

If a bank wants to change the general character of its business, it needs to obtain approval from the Federal Reserve Board under Regulation H. Apparently, neither the Fed Board, nor the San Francisco Fed considered Silvergate’s pivot to crypto to have met that standard because neither of them required the bank to file an application under Regulation H.

“The Board’s and FRB San Francisco’s narrow interpretation allowed Silvergate to enter a new business activity and gradually shift from commercial and mortgage banking activities to operating as a monoline entity serving the crypto industry without obtaining approval or implementing any conditions to address that transition,” the summary report stated.

Investigators also recommended that the San Francisco Fed should have assigned a team to facilitate Silvergate’s transition into a regional bank much sooner. Regional banks are much larger than community banks, the type of financial institution Silvergate was prior to January 2022.

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