What Caused Silvergate Bank to Eventually Fail?

Silvergate Bank

Silvergate Bank (NYSE:SI)

We can now officially say that Silvergate Bank (NYSE:SI) is no more. It fell prey to a bank run that, although not entirely their fault, might have been better buffered had they had less duration exposure on the asset side due to the volatility of Bitcoin (BTC-USD). But it should highlight what Caitlin Long (Custodia Bank) has been saying for a long time, namely, that the peculiarities of Bitcoin make it unwise for banks to lend money in exchange for cryptocurrency deposits. It’s not a question of solvency so much as the reality that inability to get cash means you’re bankrupt.

A History of the SEN Network and Its Decline

After the subprime crisis, Silvergate Bank (NYSE:SI) refocused its efforts on residential lending, despite starting as a thrift and loan in San Diego County in the 1980s. With the advent of Bitcoin in 2009, they saw an opportunity to join the cryptocurrency sector in 2014 by providing banking services to businesses operating in the Bitcoin industry. This paved the way for the development of the SEN network. The network is available around-the-clock and facilitates quick and easy money transactions between Silvergate users. Despite the crypto winter of 2018, the company’s client base expanded, and software developers were hired to meet the demand for new features. Silvergate’s zero-cost deposit base was supported by the SEN network, which also generated fees and benefited Silvergate’s clientele.

With the failure of FTX (FTT-USD), Silvergate saw a precipitous drop in deposits of digital assets, necessitating a reorganization of its balance sheet and care practices to prevent bank runs. The corporation adjusted its operations to manage the influx and outflow of deposits. Silvergate reduced its employees by almost 40 percent as part of a cost-cutting plan after analyzing its operations, products, and client connections.

Silvergate’s administration was confident in the soundness of its procedures regarding the security and availability of customer deposits. Management said they had made preparations for a 70% drawdown on deposits by maintaining cash reserves more significant than the whole amount of deposits in the bank. Caitlin Long correctly predicted that this would need to be more adequate to protect Bitcoin-accepting financial institutions.

Silvergate Is Under Intense Regulatory and Political Scrutiny

Notwithstanding the commotion and the harsh criticism of the leadership, we must investigate the reasons for this collapse. The fall of FTX was the first spark that set off a disastrous bank run on Silvergate, with customers pulling out a total of $8.1 billion. As a result, the bank was forced to sell off assets like bonds for less than their indicated value on the balance sheet, resulting in massive losses and a dilution of capital to $1 billion. Their bonds were of good grade; they would be in good shape if they could keep them till maturity. But, since interest rates were expected to rise, they were forced to sell before maturity, locking in a loss.

Nevertheless, the business took swift measures to recoup some of its losses. It recovered the upper hand for a while. But then it was reported that the Justice Department was investigating Silvergate, namely the SEN network’s handling of FTX and Alameda transactions. It needs to be made apparent what, if anything, Silvergate did wrong, but having the Feds start probing around and asking questions is a hassle and distraction that a struggling bank does not need.

Political pressure on the bank has become deafening, further damaging the institution’s already tattered image and undermining customers’ trust. The Federal Home Loan Bank of San Francisco, which had loaned the troubled entity $4.3 billion, eventually demanded repayment as the pressure mounted. There is already debate around this loan recall, with some speculating that it resulted from political pressure and selective enforcement rather than an objective regulatory judgment.

The bank’s annual report was late because of the need to reassess the losses and the bank’s capacity to continue as a going concern, which effectively sealed the bank’s fate. Due to this, the bank’s patrons lost faith in the institution. They stopped using the SEN system, essentially ending the business. The bank’s whole raison d’etre had vanished without its SEN network. The bank moved from postponing its annual report to filing for liquidation in a few days.

An Analysis of the Failure of Silvergate Bank

The bank’s problems were exacerbated by regulators, politicians, the macro environment, and the management team’s poor decisions. At first, they invested the bank’s money in cryptocurrencies. They should have been more cautious with spending or tried to get additional cash from various sources. It’s easy to second-guess their choices today. Still, we should remember that risk assessment and management are a significant part of their work.

They had blatant exposure to interest rate risk, as is evident today. They funded their operations with money from investors who traded in an asset class sensitive to interest rate changes. They held bonds that declined in value as rates rose. In addition, the rate cycle significantly impacted their bottom line, leaving them subject to market fluctuations. The most shocking part is that they offered 0% interest on deposits and paid fees for transferring money. They may have made less money but felt safer investing in Treasury notes.

I have pointed out that the management team did make errors but that the regulators also share part of the blame. Banks like Silvergate have been precarious because authorities have been reluctant and cautious in developing an appropriate framework for the cryptocurrency business. Most government bodies seem more concerned with expanding their jurisdiction into the cryptocurrency space than with learning about the nuances of the asset class and how best to do business with it. They apply laws developed in the twentieth century to a reality of the twenty-first, which is only sometimes successful or suitable. As a result of their inability to properly comprehend and regulate the market, regulators sometimes find themselves on the receiving end of legal blows.

Ultimately, deposits will likely be fully refunded, and investors may even see a return on their money. Although investors may recuperate some of their losses, it’s essential to remember that a loss is still a loss and that it’s improbable that they would get back all they invested. A bank collapse of this magnitude may be more manageable than those we have seen in the past. However, it still poses a threat of spreading to other, larger institutions in the area and beyond. Common on-ramps, such as Silvergate and Signature, are no longer an option because this catastrophe may leave permanent scars on the business. Its fate hangs in the balance regarding the Bitcoin business in the United States.

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