Silvergate Bank’s over-reliance on cryptocurrency deposits and alleged nepotism within its senior management have been identified as key factors leading to its voluntary liquidation earlier this year, according to a recent investigation by the United States Federal Reserve inspectors. The report, released on September 27, 2023, sheds light on how the once crypto-friendly institution’s missteps ultimately resulted in its downfall.
Over-dependence on cryptocurrency deposits
The Federal Reserve’s Office of Inspector General has highlighted Silvergate Bank’s shift in focus towards “customers engaged in crypto activities” as a pivotal moment that contributed to its demise. This strategic pivot, initiated in 2013, saw the bank increasingly rely on deposits from the cryptocurrency industry. The rapid growth and multi-layered funding risks associated with this approach eventually led to the bank’s voluntary liquidation.
Silvergate Bank, which started as a relatively obscure institution in the early 2010s, expanded exponentially to become the leading bank for cryptocurrency clients. Its deposits surged from $1 billion in 2017 to an astonishing $16 billion by 2021. During this meteoric rise, the bank effectively transformed into a single-industry lender, with the majority of its customer deposits being uninsured and non-interest-bearing.
If Silvergate Bank had adhered to existing banking regulations, it should have filed a new application with the Federal Reserve. However, government supervisors failed to exert enough pressure to ensure the implementation of new risk protection measures. Although some supervisors had voiced concerns about the bank’s activities, the report suggests that these concerns should have been escalated through stronger, earlier, and more decisive supervisory action.
The impact of crypto market volatility
The vulnerability of Silvergate’s business model was laid bare following the collapse of the FTX crypto exchange in November 2022, which triggered a massive outflow of capital from the cryptocurrency sector. This event underscored the inherent risks associated with being heavily reliant on the volatile crypto market.
In addition to its crypto-centric missteps, Silvergate Bank also grappled with allegations of nepotism within its senior management ranks. The report indicates that familial relationships among members of the bank’s senior leadership team undermined the effectiveness of the bank’s risk management function. This nepotism, combined with an apparent lack of competence, created an ineffective corporate structure ill-equipped to address the numerous risks it faced.
The report’s conclusion was unequivocal:
“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.”
It’s worth noting that Silvergate Bank voluntarily chose to wind down its operations in March 2023, avoiding a formal failure. This voluntary liquidation meant that the government did not have to step in and force the bank to repay depositors, sparing taxpayers from potential financial burdens.
