WASHINGTON — The Office of Inspector General for the Federal Reserve System said Monday the Fed did not act quickly enough to address the risks building up at Silvergate Bank and urged the central bank to clarify its regulatory approaches toward banks exploring novel strategies.
The Fed OIG
"We cannot publicly release our full report given Silvergate's status as an open institution and the confidential supervisory and trade secret information described in our report," the summary noted. "The public disclosure requirements outlined in section 38(k)(4) of the Federal Deposit Insurance Act do not apply to Silvergate because it has not failed or caused a loss to the Deposit Insurance Fund."
Even so, the report's summary attributes Silvergate's March
"The bank's deposit accounts were largely funded from companies in one industry, and nearly all deposits were uninsured and noninterest bearing," the summary noted. "Further, nepotism, evidenced in the several familial relationships among members of the bank's senior leadership team, undermined the effectiveness of the bank's risk management function."
The OIG noted that such factors left the bank susceptible when its main source of depositors — the crypto industry — was thrown into turmoil after crypto exchange FTX
In March 2023, the executive summary noted Silvergate's parent company, Silvergate Capital Corp., didn't submit its annual financial report to the U.S. Securities and Exchange Commission on time — saying its independent public auditor was unable to complete its audit procedures because Silvergate Capital Corp. was unable to provide the needed information, due to regulatory and legal uncertainty.
"That same month, Silvergate experienced another significant deposit outflow and the bank's holding company announced its intent to voluntarily liquidate Silvergate," the summary noted. "As of the date of this report, the bank had not failed and therefore did not result in a loss to the Deposit Insurance Fund; the bank was winding down its operations."
The summary noted that despite the fact that the Fed's
"The Board and FRB San Francisco viewed the bank's activities as traditional banking activities because the bank received cash deposits from and made loans to its crypto industry deposit customers," the summary stated. "We believe the Board's and FRB San Francisco's narrow interpretation of whether Silvergate's activities constituted a change in general character or traditional banking activities appears to directly contradict the expectation of the Board's guidance on Regulation H contained in Supervision and Regulation Letter 02-9, which is to assess the risk implications of a bank's strategy shift."
The OIG also said Fed examiners should have taken more decisive supervisory actions due to the bank's unchecked growth, volatile funding and significant weaknesses in its control functions. The executive summary also noted that the San Francisco Fed could have done a better job transitioning its supervision of Silvergate from the community bank supervision portfolio to its regional bank supervision portfolio when, in 2021, Silvergate's total assets rose above $10 billion.
"The bank transitioned from the CBO portfolio to the RBO portfolio in January 2022," they wrote. "We found that FRB San Francisco could have assigned an RBO team to Silvergate earlier to facilitate the transition."
The OIG also noted the Fed's examiner guidance lacked information to address the particular risks and susceptibility to rapid withdrawal that Silvergate's business model and deposit composition posed. They also said the Fed put insufficient pressure on Silvergate to improve its risk management capabilities and control functions despite its increasing risk profile.
The summary recommended the Fed update its Regulation H to clarify its approach to banks with changing business strategies. It recommends the Fed specify what kinds of scenarios constitute when a bank must file an application to receive approval to change business strategies.
The OIG also said the Fed should "develop guidance to ensure that banking organizations engaged in new and novel business activities have a custom-tailored supervisory plan and approach appropriate for their uniqueness and associated risks."
The summary suggested the Fed also develop guidance for examiners to better prepare firms for the transition from the CBO portfolio to the RBO portfolio and on the risks of volatile funding sources like industry-concentrated, uninsured, non-interest-bearing deposits. They also recommended additional guidance that addresses the supervision of firms with concentrated deposits from large business customers in industries which may be more susceptible to boom and bust cycles.
"In its response to our draft report, the [Federal Reserve] Board concurs with our recommendations and outlines actions to address each recommendation," the summary noted. "We will follow up to ensure that the recommendations are fully addressed."
