Editor’s Note: The NYU Program on Corporate Compliance and Enforcement (PCCE) has been following the recent banking crisis and will be publishing articles exploring the reasons for the banks’ failures and the broader regulatory, policy, and legal implications arising therefrom.
by Ijeoma Okoli
Ijeoma Okoli (photo courtesy of the author)
Introduction
On March 8, 2023, Silvergate Bank entered into voluntary liquidation. Two days later, Silicon Valley Bank (“SVB”), after experiencing a severe bank run, was taken over by regulators and with it, the most fraught weekend in global banking since the 2008 financial crisis began. Regulators in the US and UK (SVB had a UK banking subsidiary) scrambled to ensure that there were solutions in place before Asian markets opened Sunday night, East Coast time. Tech founders in Silicon Valley and the many venture capital firms (“VCs”) backing them used social media to rally the troops to put pressure on governments to ensure that they had access to their money by open of business the following Monday morning.
By Sunday night, March 13, 2023, it was announced that the Federal Deposit Insurance Corporation would guarantee all deposits of SVB and Signature Bank without limits, the first time in US history, and create the Bank Term Funding Program to make “additional funding available to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors” by allowing these institutions to borrow amounts and pledge as collateral their portfolio of bonds at par.[1] In the UK, SVB’s local subsidiary was sold to the banking giant, HSBC, which although it was reportedly solvent, had been caught up in the troubles of its American parent.[2] Silicon Valley and Silicon Roundabout[3] breathed a collective sigh of relief; their startups would be able to make payroll that week and their money was safe. However, Monday morning, March 15th, brought news that another regional bank, First Republic Bank, may be in trouble as its stock plummeted upon market open. On the Tuesday, Charles Schwab was another focus and on Wednesday, the panic spread to Switzerland and long troubled Credit Suisse was next, with the Swiss National Bank ultimately having to step in to back stop Credit Suisse as its stock hit historic lows. The behavior of the market was similar to that which we last saw in 2008, with strong selling pressure on the stock of one bank after another, until it folds or until government agencies and departments or competitors step in to avert systemic failure of the banking system. The difference this time is that, with the exception of Credit Suisse which had long experienced troubles, both financial and reputational and which on March 19, 2023, was ultimately bought by its Swiss rival, UBS, for $3.25 billion,[4] and temporarily Charles Schwab,[5] the focus of this panic seemed to be almost exclusively on the regional US banking sector. Ironically, the too big to fail banks have gotten bigger with depositors racing towards these large banks and money market funds for safety.[6] The strength of large banks in the US was reinforced when on March 16, 2023, some of the largest banks in America injected $30 billion in deposits into First Republic Bank.[7]
What caused this banking sector panic and why did it seemingly seem to come out of nowhere? The reasons are multifold. Each bank’s management is wholly responsible for the failures, but there were some factors that stood out and contributed to the bank collapses, including sectoral client concentration (i.e. lack of diversified funding sources), agile depositors egged on by a social media age panic causing bank runs, rising interest rates, lack of adequate risk management, particularly in relation to interest rate risk and maturity mismatch; a perfect storm of seemingly unrelated elements. It is worthwhile noting that there have been voices in the media blaming crypto for the current crisis, however, the business of these banks was taking deposits and making loans, not owning crypto assets as principal or speculating on crypto assets. Furthermore, even the White House’s Economic Report of the President published on March 20, 2023, which was harshly critical of the crypto assets sector generally, acknowledged that “there has not yet been a systemic crisis caused by crypto assets,” which given that the report was published almost two weeks after the current banking crisis began, one could assume that the White House considered the current crisis before making that statement.
Client Concentration
Silvergate Bank and Signature Bank set up real time cash settlement mechanisms (the Silvergate Exchange Network and Signature’s Signet network, respectively) which allowed participants in the crypto assets sector to move money among themselves at all times of the day, including after business hours. Silvergate, which described itself in the last Annual Report (Form 10-K) that it filed with the Securities and Exchange Commission (“SEC”) in February 2022 as “the leading provider of innovative financial infrastructure solutions and services to participants in the nascent and expanding digital currency industry” and at one point served “over 750 of the most recognized and well-funded digital currency exchanges, institutional investors, and software developers in fintech”[8] with the crypto assets sector providing most of Silvergate’s funding (approximately 58% of its total deposit base came from crypto exchanges) for the 4 years leading up to 2022.[9] The crypto asset sector represented 20% of Signature Bank’s deposits as of December 31, 2022 down from approximately 28% the prior year, according to the bank’s Form 10-K for the fiscal year ended December 31, 2022. SVB in turn was widely known as the go to bank for tech entrepreneurs and according to its Form 10-K for the fiscal year ended December 31, 2022, its deposits were largely derived from commercial clients within its technology, life science/healthcare and private equity/venture capital sectors.[10] SVB’s deposit growth slowed in the second half of 2022 from the rapid growth it saw in the 18 months prior due to a decrease in client liquidity events like IPOs, secondary offerings and venture capital investments, along with clients moving funds from bank accounts into off-balance sheet products like third-party money market funds.[11] This concentration among the client bases of the banks made it such that as the relevant client sectors experienced difficulties, the banks did as well.
Rising Interest Rates, Client Concentration and Social Media Led to a Bank Run
As alluded to in SVB’s December 31, 2022 10-K and a Silvergate call with analysts in January 2023[12], in some cases, many depositors sought to withdraw their deposits in order to invest elsewhere as the Federal Reserve hiked rates aggressively and risk-free treasuries became very attractive.[13] As depositors drained their accounts, SVB announced in a March 8, 2023 SEC 8-K filing that it had sold virtually all of its available for sale bond portfolio at a $1.8 billion loss[14] alongside plans to raise additional capital, which caused many investors to sell their shares, putting downward pressure on SVB’s parent company’s stock price.[15]
Silvergate’s proximity to and concentration of its business in the crypto sector meant that when the crypto exchange, FTX, a Silvergate client reportedly worth $1 billion in business to the bank, collapsed spectacularly amid accusations of fraud and incompetent management, spooked depositors rushed to withdraw deposits from Silvergate (it lost 68% of its crypto sector related deposits totaling $8.1 billion in the fourth quarter of 2022) and Silvergate was forced to sell securities it once intended to hold until they matured at a loss in order to satisfy withdrawal demands.[16]
Spooked by the collapse of SVB and Silvergate, Signature Bank’s stock price also came under pressure and depositors withdrew their deposits, with $10 billion in deposits exiting the bank on Friday, March 10th alone.[17]
Short sellers also contributed to the pressure on bank stocks. Silvergate’s shares were heavily shorted, and netted short sellers (who make bets that particular company’s shares will go down in price and profit from the declines) more than $780 million in profits in four months to March 2023 with $190 million of that made in the week before the bank collapsed.[18] Short sellers also heavily targeted SVB and Signature[19] which also caused downward pressure on their stock with SVB short sellers making $600 million on March 9th alone.[20] The downward pressure on the banks’ stocks increased the unrealized losses when weighed against the banks’ held to maturity portfolios and the mark to market losses of their available for sale securities.
Social media played a part in stirring the panic that led to runs on the three banks. On social media platforms some VCs began to urge their portfolio companies to withdraw their deposits from SVB.[21] The panic begat a bank run and the lack of sufficient risk management and the losses that the bank run made the banks recognize resulted in Silvergate ultimately deciding to go into voluntary liquidation and US banking regulators taking control of SVB. The action of the banking regulators against Signature Bank was a preemptive one in order to prevent it from suffering from losses like Silvergate and SVB.
Despite issues like the concentration risk relating to the client bases of these banks and the interest rate risk encountered by the banks as a result of the Fed’s rate increases, the banks did not adequately manage these risks. In fact, SVB proactively removed most of the hedges that sought to manage the interest rate risk on its bond portfolio last year.[22]
The Future
Management of some or all of the banks that failed may be subject to investigations by authorities – it is already being reported that the SEC and the US Department of Justice are investigating the collapse of SVB.[23] There is also the possibility that some of those who fanned the flames on social media for the runs on the banks which helped depress the stock prices could face potential investigations for acts like market manipulation given that these banks all had publicly traded securities. There are also questions as to why bank supervisors either did not pick up on, or did not address, issues with the banks before they ran into trouble.
There had been reports of requirements for the ultimate purchaser of Signature Bank to divest from its crypto business, i.e., not bank crypto firms. The FDIC has denied this.[24] Nevertheless, it would be the wrong decision to exclude crypto market participants from being able to obtain banking services and/or to blame the crypto sector for the chaos rather than the banks’ management or in fact aggressive interest rate hikes (interest rates rose by 1,700% in less than a year,[25] reportedly the most extreme rate hike cycle in 40 years[26] and eerily in the days before Silvergate fell, Senator Elizabeth Warren queried Fed Chair Jerome Powell about the unintended consequences of the Fed’s aggressive rate hikes[27]). In the aftermath of the 2008-2009 financial crisis, regulators did not seek to prohibit firms from engaging in real estate mortgage business or derivatives transactions, two of the culprits of that crisis, rather in the aftermath of that crisis, regulators imposed tighter mortgage standards and, implemented an entire derivatives regulatory regime, embedded in Section VII of the Dodd-Frank Act of 2010, to both protect consumers and reduce risks to the financial system. And that is exactly what is needed here rather than attempts to restrict any sector’s access to financial services.
One interesting realization that has been brought to the fore by the recent banking crisis is ironically the potential risk it highlighted relating to bank risks to crypto asset market participants. Treasury Secretary, Janet Yellen, and the Bank of England[28] have heretofore indicated that given the limited size of the crypto sector compared to the traditional market economy, the crypto sector does not pose financial stability risks, but it could pose such risks in the future and should rightly be monitored. However, the questions around financial stability risks should also now include, given these recent developments, particularly in relation to SVB, questions about whether this one directional view of risk is adequate or appropriate. For the avoidance of doubt, this paper is not suggesting that the cryptocurrency sector is to blame for the 2023 Banking Crisis, the blame lies squarely on shoulders of the traditional finance sector, of which the relevant banks were members, but at the same time, the cryptocurrency sector has issues that could pose investor protection, market integrity and financial stability risks. However, one should also consider whether traditional finance has in turn injected a previously unforeseen or underappreciated element of risk into the crypto asset sector given that $3.3 billion of cash backing the stablecoin, USDC, was locked in a bank account at SVB as it collapsed and the revelation of that stuck cash sent the trading price of USDC, which should have been at par with $1 plummeting to as low as $0.88.
Footnotes
[1] The Fed – Bank Term Funding Program (federalreserve.gov).
[2] What happened to Silicon Valley Bank UK? | Bank of England.
[3] Silicon Roundabout is a nickname for London’s technology hub in the eastern part of the city.
[4] Credit Suisse-UBS deal offers hope, but bank doubts persist | AP News.
[5] Charles Schwab Says It Could Ride Out a Deposit Flight – WSJ.
[6] It’s raining money on Bank of America. Inflows of over $15 billion reportedly seen amid SVB fallout (msn.com); Charles Schwab clients poured in $17 billion last week as the spiraling bank crisis sent money to a ‘safe port in a storm’ (msn.com); Money market funds swell by over $286bn as investors pull deposits from banks | Financial Times (ft.com)
[7] Major US banks inject $30 billion to rescue First Republic Bank | Reuters.
[8] Digital Currency & Fintech Solutions | Silvergate Bank | San Diego.
[9] See Item 1. Business and Item 1A. Risk Factors of Silvergate Capital Corporations Form 10-K for the fiscal year ended December 31, 2021.
[10] See Item 1. Business and Item 1A. Risk Factors of SVB Financial Group (Silicon Valley Bank’s parent) Form 10-K for the fiscal year ended December 31, 2022.
[11] See Item 1A. Risk Factors of SVB Financial Group (Silicon Valley Bank’s parent) Form 10-K for the fiscal year ended December 31, 2022.
[12] Silvergate Raced to Cover $8.1 Billion in Withdrawals During Crypto Meltdown – WSJ.
[13] Silicon Valley Bank Failure Signals Widespread Risk Amid High Interest Rates (businessinsider.com); Silvergate Raced to Cover $8.1 Billion in Withdrawals During Crypto Meltdown – WSJ.
[14] SVB says Goldman Sachs was buyer of portfolio it booked losses on | Reuters; SVB Financial Group – Financials – SEC Filings – SEC Filings Details.
[15] How Silicon Valley Turned on Silicon Valley Bank – WSJ.
[16] Silvergate Raced to Cover $8.1 Billion in Withdrawals During Crypto Meltdown – WSJ; Silvergate | Silvergate Announces Select Preliminary Fourth Quarter 2022 Financial Metrics and Provides Business Update.
[17] Signature Bank: Third-biggest bank failure in U.S. history (cnbc.com).
[18] Silvergate Short-Sellers Make $780 Million As the Crypto Bank Shuts Down (businessinsider.com).
[19] SVB collapse leads to big paydays for short-sellers (yahoo.com).
[20] Short-sellers make $600m in one day on Silicon Valley Bank crisis – Financial News (fnlondon.com).
[21] How Silicon Valley Turned on Silicon Valley Bank – WSJ.
[22] Interest rate risk: SVB’s nemesis a well-known foe in banking (yahoo.com).
[23] SEC and Justice Department: Silicon Valley Bank investigation (cnbc.com).
[24] Flagstar Bank on March 19, 2023, ultimately purchased most of Signature’s deposits and some loans. About $4 billion of deposits related to Signature’s digital business was not included in the purchase and will remain under Federal Deposit Insurance Corporation (“FDIC”) control (Flagstar Bank to take over most of Signature Bank’s deposits, FDIC says – MarketWatch).
[25] Silicon Valley Bank Failure Signals Widespread Risk Amid High Interest Rates, Business Insider (March 11, 2023).
[26] ICYMI: At Hearing, Senator Warren Calls out Chair Powell for Fed’s Plan to Throw At Least 2 Million People Out of Work | U.S. Senator Elizabeth Warren of Massachusetts (senate.gov).
[27] Although Senator Warren’s focus was on the loss of jobs as a direct consequence of the rate hikes, the collapse of SVB, Silvergate and Signature and the ensuing chaos, may be attributable to something breaking, as a result of the Fed’s aggressive rate hike (See also SVB is clearly an example of something breaking, says Charles Schwab’s Liz Ann Sonders (cnbc.com)).
[28] Janet Yellen says risks related to stablecoins are ‘growing very rapidly’ but they’re not yet a real threat to financial stability | Business Insider India; Financial Stability in Focus (bankofengland.co.uk).
Ijeoma Okoli is a finance and regulatory lawyer and strategic adviser on digital assets; a co-Director of the Digital Economy Initiative, an independent digital assets think tank in London focused on US and UK digital assets public policy and a founding member and limited partner of Impact X Capital Partners, an ESG focused venture capital fund. She previously was an Executive Director and Digital Currency Risk Management Lead at JPMorgan focused on designing the firm’s global digital currency risk management and governance framework and advising on crypto related business proposals.
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