Editor’s Note: The NYU Program on Corporate Compliance and Enforcement (PCCE) has been following the recent collapse of three banks in the U.S. and will be publishing articles exploring the reasons for the banks’ failures and the broader regulatory, policy, and legal implications arising therefrom.

by Maria T. Vullo

Over the past ten days, three midsize U.S. banks have failed: Silvergate Capital (Silvergate), a $12 billion bank, announced its voluntary liquidation on March 8, 2023[1]; Silicon Valley Bank (SVB), a $210 billion bank, was closed by its California state regulator with the Federal Deposit Insurance Corporation (FDIC) appointed receiver on March 10, 2023[2]; and Signature Bank (Signature), a $110 billion bank, was closed by its New York state regulator with the FDIC appointed receiver on March 12, 2023.  While Silvergate voluntarily closed its doors with a promise to return all depositor funds, for both SVB and Signature, the FDIC triggered the “systemic risk” exception to the “least costly” requirement of receivership, in order to provide full insurance protection to all depositors.[3]  As receiver, the FDIC has removed senior management, appointed new chief executive officers, and bank operations are continuing while the FDIC considers possible acquisitions and other remedies.[4]

Media reports are littered with opinions as to the potential causes of these bank failures, and some of the reporting includes finger pointing at the crypto industry.  While additional facts undoubtedly will be disclosed in the weeks and months ahead, based on current information, it would be overly simplistic to blame the failures of SVB and Signature on any one cause, given that various market, regulatory and human factors appear to have contributed to their demise. 

Silvergate Capital

Silvergate was the smallest bank of the three, with approximately $12 billion in assets.  Silvergate’s customer base was entirely in the crypto industry and, according to news reports, its customer deposits declined from $11.9 billion to $3.8 billion following the collapse of cryptocurrency firm FTX in late 2022.[5]  This sharp decline in the bank’s deposits resulted from the recent drops in crypto values, causing its customers to suffer losses.  In addition, media reported that the U.S. Department of Justice is investigating Silvergate in connection with funds transfers between FTX and Alameda.[6]  On March 8, 2023, Silvergate management decided to voluntarily liquidate the bank.

In short, Silvergate’s demise appears to be the result of its concentrated business model:  it had a customer base in one industry, and this substantial concentration risk materialized when the bank’s customers suffered financial losses which resulted in significantly reduced deposits – and cash — at the bank.  In supervising banks, regulators must consider concentration risk, which may present itself in varied ways, and the diversification of a bank’s business mitigates its risk.  Here, unquestionably, Silvergate’s exposure to one industry in its customer base contributed to its demise.

Silicon Valley Bank

SVB’s failure also may be attributed to concentration risk, resulting from the fact that its deposit customers were concentrated in large venture-capital firms and start-up companies that recently had experienced losses.  More importantly, 90% of the bank’s customer deposits were above the $250,000 per account FDIC deposit insurance limit.[7]  While some of these customers were crypto firms, it was SVB’s overall uninsured depositor base that apparently caused the “run on the bank” as such customers lack the incentive to maintain their deposits in the event of even a hint of turmoil at the bank.  Along with apparent management failures, SVB’s business model proved fatal when its customers withdrew funds in large amounts, resulting in its demise.[8]

Moreover, SVB’s business model of uninsured depositors was fraught with liquidity risk, which SVB apparently did not manage adequately.  For example, according to reports, SVB invested in long-term U.S. Treasury and mortgage-backed securities which it recently sold at significant losses given the current higher interest-rate environment, to satisfy customer withdrawals.  Astonishingly, it appears that SVB management had terminated its interest-rate hedging contracts by the end of 2022, leaving the bank with no protection against such losses in this known higher-interest rate environment, resulting in yet additional customer withdrawals.  It also has been reported that the bank’s Chief Risk Officer departed in April of 2022.[9]  These facts raise significant questions about the bank’s risk management, particularly given its business model and concentration risk.

SVB’s failure also appears to be tied to its rapid growth in response to the loosening of regulatory requirements for banks of its size.  Following the 2007-08 financial crisis, the Dodd-Frank Act of 2010 imposed heightened capital, liquidity risk management, and stress-testing requirements on banks with assets of at least $50 billion.  In 2018, SVB’s assets were just under that threshold, at $49 billion, and SVB, Signature and other banks advocated that the Trump Administration increase the $50 billion threshold.[10]  In May 2018, Congress passed, and President Trump signed, legislation that rolled back certain Dodd-Frank requirements, including an increase of the threshold to $250 billion for the enhanced prudential requirements.  Over the next few years, SVB grew rapidly, quadrupling its assets to $200 billion by 2021.[11]   Even without the change in regulatory framework, a bank’s exponential growth in such a short period of time is a red flag and required strengthened risk management, particularly for a bank with 90% uninsured deposits.  Accordingly, it is welcome news that Michael Barr, the current Vice Chair for Supervision of the Federal Reserve, is leading a review of SVB’s supervision and has committed to publishing the results of such review by May 1, 2023.[12]

Signature Bank

While Signature bears some similarities to SVB, its customer profile is quite different.  In contrast with both Silvergate and SVB, Signature’s customer base was more diversified and included substantial real estate business, small business and law firm customers, and a private wealth management business.  Like Silvergate and SVB, Signature had crypto customers, though it had reduced some of its crypto customer base in recent months.  Moreover, though Signature was half the asset-size of SVB, like SVB, Signature grew in size over a short time period, more than doubling its asset size from $47 billion at the end of 2018 to $118 billion at the end of 2021, and $110 billion as of December 31, 2022.[13]  It appears that the SVB bank run on March 9-10, 2023, may have led to a bank run at Signature and other regional banks, leading the public and regulators to fear “contagion” within the broader banking industry.[14]  

Indeed, by the time Signature’s regulators acted on March 12, 2023, talk was rampant about the risk of “contagion” affecting medium and small banks.  Based on public reports, Signature had suffered significant customer withdrawals and a drop in its stock price on Friday, March 10, with withdrawals continuing over the weekend.  Accordingly, on Sunday, March 12, Signature’s regulators took over the bank, and the Federal Government’s decision to protect all depositors at both SVB and Signature led to increased public confidence in the banking industry, thereby stemming the tide of further bank runs.[15] 

Although a Signature director has asserted that the regulators’ decision to take over Signature was intended to “send a message” to the crypto industry, the New York state regulator has rejected this suggestion.[16]  While additional facts likely will be revealed in the coming weeks and months, it appears that the regulators’ decision with respect to Signature was based on the bank’s significant customer withdrawals and concerns about contagion.  As with SVB, the bank’s customer base in uninsured deposits contributed significantly to its risk of customer withdrawals.  It does not appear that any policy decision regarding cryptocurrency had, nor could have had, any role in the decision.  Instead, the decision appears to have been made based on the bank’s safety and soundness, including the lack of “stickiness” of its customer deposits, and contagion risk.  It is anyone’s guess to what degree customers would have continued to withdraw funds on Monday morning had the regulators not acted, but the risk of contagion in that event likely was too great to roll the dice.[17]

Systemic Risk, Bailouts, and Moral Hazard   

Some have questioned how banks with $210 billion and $110 billion in assets, respectively, could be deemed “systemic risks” to the U.S. banking industry which has over $23 trillion in assets.[18]  Indeed, SVB and Signature had argued to Congress in 2018 that banks with assets under $250 billion could not be deemed systemic!  By triggering the “systemic risk” exception, the FDIC has made clear that the failure of any bank may be “systemic” regardless of its size.  At least in the case of SVB, the systemic risk likely was caused by the bank’s inadequate risk management and other failures to address its business model and concentration risk in uninsured deposits.  In addition to Vice Chairman Barr’s review, it has been reported that the U.S. Department of Justice has opened an investigation into SVB, suggesting that additional information might come to light that may further explain that bank’s demise.[19]

In announcing their decision to protect all uninsured deposits at SVB and Signature, Treasury Secretary Yellen and the federal banking agencies took pains to make clear that their actions do not constitute a “bailout” of banks such that shareholders and unsecured debtholders will not be protected.[20]  But even without bank “bailouts”, there is a question whether the extension of deposit insurance will result in increased “moral hazard” that will incentivize bankers to undertake risky activities in the future.  As such, regulators and, if necessary, law enforcement must fully investigate the causes of these bank failures and, if warranted, commence the necessary proceedings against all responsible persons.  Unless individuals are held accountable for misconduct, future bankers and bank shareholders will take actions that create greater risk and will continue to advocate for relaxed regulatory rules in the pursuit of increased profits.  

Finally, FDIC insurance, created following the 1929 stock market crash and collapse of the banking system, relies on the principle that most depositors have less than the deposit insurance limit on account at their bank.  Since both SVB and Signature relied primarily on uninsured depositors, regulators should consider heightened capital, liquidity and stress-testing requirements for banks with similar business models, in contrast with many other regional and local community banks that cater to retail customers with accounts under the FDIC insurance limit.   In addition, risk-based capital rules should be reconsidered in light of the current interest-rate environment, recognizing that very low interest rates are unlikely to return. 

The failures of SVB and Signature demonstrate that it isn’t only the “too big to fail” banks that can cause systemic risk.  Given the events of the past week, the strength of the U.S. banking system depends on (1) a comprehensive review and necessary strengthening of regulatory requirements to address the risks and moral hazards underlying different bank business models, deposit insurance, and contagion risk, and (2) strong government action that both punishes any proven wrongdoing and deters future risk management failures and decision-making that creates unacceptable risk to depositors and the Insurance Fund.

Footnotes

[1] Form 8-K Filed with the U.S. Securities & Exchange Commission by Silvergate Capital Corporation, March 8, 2023, https://d18rn0p25nwr6d.cloudfront.net/CIK-0001312109/4a9631da-2e92-4df5-b425-7fd5c9e91da5.html. 

[2] Press Release, Federal Deposit Insurance Corporation, March 10, 2023, https://www.fdic.gov/news/press-releases/2023/pr23016.html.

[3] Joint Statement by the Department of the Treasury, the Federal Reserve, and FDIC, March 12, 2023, https://www.fdic.gov/news/press-releases/2023/pr23017.html?source=govdelivery&utm_medium=email&utm_source=govdelivery.

[4] In order to permit the banks’ continued uninterrupted operations, the FDIC created federal bridge banks for SVB and Signature.  See Press Releases, Federal Deposit Insurance Corporation, March 12 and 13, 2023, https://www.fdic.gov/news/press-releases/2023/pr23019.html; and https://www.fdic.gov/news/press-releases/2023/pr23018.html.

[5] See David Hollerith, Yahoo Finance, “Silvergate Capital will liquidate after crypto collapse wipes out bank,” March 8, 2023, https://finance.yahoo.com/news/silvergate-capital-will-liquidate-after-crypto-collapse-wipes-out-bank-220356639.html.

[6] Reuters, “U.S. prosecutors probe Silvergate’s dealings with FTX, Alameda,” February  2, 2023, https://www.reuters.com/technology/us-prosecutors-probe-silvergates-dealings-with-ftx-alameda-bloomberg-news-2023-02-02/.

[7] The commercial bank model relies on customer deposits to fund the bank’s lending businesses.  As such, banking relies on what is called “fractional reserve banking,” whereby only a fraction of customer deposits is maintained in cash or cash equivalents for customer withdrawals, on the premise that not all customers will withdraw their funds at the same time.  And FDIC insurance provides bank customers with security so that they will not withdraw their funds simultaneously based on fear of financial loss.  When customer deposits are in excess of FDIC insurance limits, as they were at SVB, the risk to the bank’s liquidity is significant and must be addressed.

[8] Evan Griffith and Mike Isaac, The New York Times, “After Bank Debacle, Silicon Valley Reckons With Its Image,” March 13, 2023, https://www.nytimes.com/2023/03/13/technology/silicon-valley-image.html?campaign_id=9&emc=edit_nn_20230314&instance_id=87661&nl=the-morning&regi_id=104526787&segment_id=127725&te=1&user_id=80dbb1f254e89cdb1562946f1d8d5791.

[9] Ben Eisen, Ben Foldy, Justin Baer, and Hannah Miao, The Wall Street Journal, “CEO Greg Becker Was There for SVB’s Quick Rise and Even Quicker Fall,“ March 13, 2023, https://www.wsj.com/articles/greg-becker-was-there-for-svbs-quick-rise-and-even-quicker-fall-2ff25176.

[10] Julie Bykowitz, The Wall Street Journal, “Barney Frank Pushed to Ease Financial Regulations After Joining Signature Bank Board,” March 13, 2023, https://www.wsj.com/articles/barney-frank-pushed-to-ease-financial-regulations-after-joining-signature-bank-board-e5c8819c.

[11] At the time of its seizure by the FDIC on March 10, 2023, SVB had $209 billion in assets and $175.4 billion in deposits as of December 31, 2022.  See Press Release, Federal Deposit Insurance Corporation, March 10, 2023 (updated March 12, 2023), https://www.fdic.gov/news/press-releases/2023/pr23016.html.

[12] Press Release, Board of Governors of the Federal Reserve System, March 13, 2023, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20230313a.htm.

[13] YCharts, Signature Bank Assets, https://ycharts.com/companies/SBNY/assets; Press Release, New York State Department of Financial Services, March 12, 2023, https://www.dfs.ny.gov/reports_and_publications/press_releases/pr20230312.

[14] Matthew Goldstein and Emily Flitter, The New York Times, “Risky Bet on Crypto and a Run on Deposits Tank Signature Bank,” March 12, 2023, https://www.nytimes.com/2023/03/12/business/signature-bank-collapse.html.

[15] See footnote 4, supra; Sean Mason, Proactive Research, “First Republic Bank, Western Alliance Bancorporation  lead regional bank stock rally as contagion fears ease,” March 14, 2023, https://www.proactiveinvestors.com/companies/news/1009027/first-republic-bank-western-alliance-bancorporation-lead-regional-bank-stock-rally-as-contagion-fears-ease-1009027.html.

[16] Leo Schwartz, Fortune, “’Nothing to do with crypto’: Regulators pour cold water on Barney Frank’s claim Signature Bank was targeted.” March 14, 2023, https://fortune-com.cdn.ampproject.org/c/s/fortune.com/crypto/2023/03/14/nothing-to-do-with-crypto-regulators-barney-frank-signature/amp/.

[17] Although not confirmed, media reports indicate that the U.S. Department of Justice and the SEC may have been investigating Signature for possible anti-money laundering violations related to its crypto customers at the time its regulators took action on March 12, 2023.  See Tom Schoenberg, Ava Benny-Morrison and Austin Weinstein, Bloomberg, “Signature Bank Faced Criminal Probe Ahead of its Collapse,” March 14, 2023 (updated March 15, 2023), https://www.bloomberg.com/news/articles/2023-03-15/signature-bank-faced-criminal-probe-ahead-of-firm-s-collapse?leadSource=uverify%20wall.

[18] FDIC – Statistics At A Glance As Of December 31, 2022, https://www.fdic.gov/analysis/quarterly-banking-profile/statistics-at-a-glance/2022dec/industry.pdf.

[19]  In addition to the risk management failures described above, reports indicates that SVB senior management sold stock and paid bonuses shortly before the bank’s demise.  See Matthew Goldstein and Katie Benner, The New York Times, “U.S. Is Said to Open Investigation Into Silicon Valley Bank Collapse, March 14, 2023, https://www.nytimes.com/2023/03/14/business/silicon-valley-bank-investigation.html?smid=nytcore-ios-share&referringSource=articleShare.    

[20] See footnote 4; see also Interview of Treasury Secretary Janet Yellen, CBS News, Face the Nation, March 12, 2023, https://www.youtube.com/watch?v=oTi8rlPno8s.  These statements are responsive to concerns raised following the 2007-08 financial crisis about the use of taxpayer money for “bailouts” of banks and other financial institutions.  As a result, the Dodd-Frank Act prohibits taxpayer bailouts and instead created “orderly liquidation authority” by the FDIC.  See The Obama White House Archives: Wall Street Reform: The Dodd-Frank Act, https://obamawhitehouse.archives.gov/economy/middle-class/dodd-frank-wall-street-reform.

Maria T. Vullo is the former Superintendent of Financial Services for the State of New York, and presently serves as a Senior Fellow for PCCE.  In addition, Ms. Vullo is the CEO of Vullo Advisory Services, PLLC, Regulator-in-Residence at the Fintech Lab NYC, and an Adjunct Professor of Law at Fordham Law School.

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