The failure of Silvergate Capital Corp could mark the first time that poor liabilities rather than bad assets have brought down a financial institution. In most cases, people panic and withdraw all their money from a bank because they are afraid of losing their investment in the form of loans, rather than because all their liabilities are in one market.
How the collapse might have happened
Depositors’ panic increased when the California bank said in a statement last week that it might not be able to remain in business according to a Bloomberg report.
During the height of the pandemic’s crypto boom, Silvergate’s deposit base surged, rising from $1.8 billion at the end of 2019 to a peak of $14.3 billion at the end of 2021. This trend reversed as the crypto bubble deflated, particularly in the fourth quarter of 2022 following the fall of FTX. The stock of the bank has seen a similar roller coaster journey.
The bank extended credit against crypto assets, and in January it was revealed that the Justice Department was looking into the bank for criminal violations related to its dealings with FTX. The fundamental weakness in its business strategy was already in place, though. To be more precise, its deposits weren’t deposits in the conventional sense.
For Silvergate to succeed, money has to flow in and out of the system only to settle trades involving a narrow range of assets. If you weren’t planning on exchanging the goods in question, there was no point in keeping any money at or going through Silvergate.
During times of stress, large financial institutions are required to have sufficient high-quality liquid assets to cover deposits for at least 30 days. At the end of 2022, for instance, JPMorgan Bank & Co. owned $733 billion in such assets alongside $2.3 trillion in other traditional deposits. Most of the remainder was invested in Treasuries and government-sponsored mortgage bonds, while the other 30% was held in bank deposits at the Fed and other financial institutions.
More risk was taken by Silvergate. Much of its fresh capital has been invested in longer-term instruments. Only 11% of its most liquid assets were cash at the Fed and other banks at the end of the third quarter of last year, before deposits began to shrink rapidly. The rest of its assets were in the form of securities. In fact, only 11% of the securities were really issued by the Treasury. The rest were almost all mortgage-backed bonds with maturities of more than ten years. Before Silvergate started selling off its bond assets to cover withdrawals, the fair value of the bonds had dropped by $1 billion.
Silvergate was not required to comply with liquidity regulations because of its size. It’s possible it would have made them anyhow, but authorities should have looked more closely at its unusually rapid expansion and the common source of its deposits before the money started disappearing as swiftly as it had arrived.
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