Observations and Implications of the Fallout from Silvergate, SVB and Signature

The views expressed below are those of the author and not necessarily of the New York City Bar Association. 

By Jerome Walker[1]
Co-Chair, City Bar Task Force on Digital Technologies; Co-Chair, Technology, Cybersecurity and Data Privacy Subcommittee, City Bar Compliance Committee

Even a cursory review of the voluntary liquidation of Silvergate Bank (Silvergate), and the failures of Silicon Valley Bank (SVB) and Signature Bank (Signature) bring into sharper focus the critical importance of trust and confidence in the financial system. Indeed, many of the responses by the California Department of Financial Protection and Innovation (DFPI) with respect to Silvergate; the DFPI, the Board of Governors of the Federal Reserve System (Federal Reserve) and the Federal Deposit Insurance Corporation (FDIC) with respect to SVB; the New York State Department of Financial Services (DFS) and the FDIC with respect to Signature; and the Federal Reserve, the FDIC and the US Department of the Treasury (Treasury) with respect to SVB and Signature were motivated by the need to restore trust and confidence in the US financial system.

One of the primary lessons learned from the recent financial crisis has been that when trust and confidence are eroded in one segment of the US financial system, then that erosion of trust and confidence could rapidly spread to other types of financial institutions and threaten the entire financial system. The fear of this type of systemic risk, and the potential contagion that could have spread more rapidly across the financial system is what prompted quick intervention and extraordinary measures taken by Treasury and the prudential supervisors at the state and federal levels.

While historically the importance of trust and confidence in the financial system has been understood and protected, what has not been understood and what has left the financial system unprotected in this financial crisis is the lightning speed at which the fear of contagion and lack of trust and confidence could spread in such a short period of time.[2] US policymakers[3] are now asking whether the US needs to rethink the causes and consequences of systemic risk and how to prevent it, manage it, and contain it. While there continues to be widespread disagreement on what caused the recent crisis, there is also a consensus expressed by the Federal Reserve, the FDIC, and the Treasury that prudential supervisors must make changes to their supervisory policies and their regulations to ensure the US financial system is even stronger and more prepared to withstand shocks to the financial system caused by advances in technology, and especially the speed at which information, even incorrect information, is spread and acted upon to the detriment of some market participants. For instance, some commentators have suggested that the failure of FTX was a cause of the voluntary liquidation of Silvergate. Similarly, other commentators have asserted that the bank run on SVB was caused and exacerbated by hasty decisions made by venture capitalists (in some cases through social media like Twitter), that not only withdrew funds from SVB, but also caused their portfolio companies to withdraw funds from SVB. Likewise, still other commentators have posited that fears about the failure of SVB caused a bank run not only on Signature, but also on First Republic Bank[4] (First Republic). Many commentators also believe the risk of the spread of contagion was a decisive factor in DFS’s decision to close Signature, and but for the actions of the Federal Reserve, the FDIC, the Treasury, and a number of the largest US commercial banks, the fear of the spread of contagion would have brought down First Republic and a number of other regional banks. In a very negative, but very extraordinary way, these events all occurred (often simultaneously) over the course of a matter of weeks during March.

Fortunately, the prompt, coordinated and timely actions taken by governmental agencies at the state and federal level, and by some of the largest commercial banks in the US, have now calmed markets, showcased the resiliency of the US banking system, and returned the US financial system to a solid footing. It appears that the contagion has been contained and now the focus can shift from preventing untold harm to the financial system to reviewing the supervisory approach to financial institutions with different business models; the efficacy of current financial institutions laws; the appropriate roles and responsibilities and supervision of existing and new market participants; how each of the different market participants interact with each other; and how that interplay could affect the financial stability of the US financial system when a panic occurs. Indeed, the current financial crisis creates an opportunity for policymakers and governmental agencies to determine how to modernize[5] US financial regulation and supervisory policy in light of the different market participants; the role of technology in creating and enhancing the products and services offered; the technology driven assets created; and the types of entities participating in the financial system. This opportunity must not be slowed or halted by the commencement or continuation of numerous necessary investigations to determine what happened, how to prevent or limit future occurrences, and how and to whom to hold accountability. There is certainly enough blame to go around. Nonetheless, policymakers and regulatory agencies should forge ahead and review, and, in some cases, update existing laws and make new laws that take into account current market participants and the roles and responsibilities they play in the financial system. Policymakers and governmental agencies should avoid the endless series of finger pointing[6] that normally accompanies a financial crisis.

This article summarizes the events surrounding the collapse of Silvergate, SVB, and Signature, and then provides some observations and implications arising from the fallout from the collapse.

The Voluntary Liquidation of Silvergate

On March 8, 2023, the DFPI announced that Silvergate, a $11.353 billion[7] (as of December 31, 2022) California state member bank under the supervision of the DFPI and the Federal Reserve,[8] had voluntarily begun the process of liquidation.[9]  Media reports indicate that Silvergate operated under a nondiverse business model that focused primarily on providing services to the cryptocurrency industry. If this is true, then a plausible case could certainly be made that Silvergate’s demise was caused by its risky business model; its concentration risk; the volatility of the cryptocurrency market, including the crypto winter; and the lack of confidence and trust investors showed in cryptocurrency and cryptocurrency platforms. The voluntary liquidation of Silvergate is yet another opportunity for the Securities and Exchange Commission (SEC)[10] and the Commodities Futures Trading Commission (CFTC) to work together with policymakers to develop a comprehensive framework for regulating and supervising the cryptocurrency industry. The current approach of both the SEC and the CFTC is to use enforcement actions to provide guidance in some cases, and, in other cases, to make public announcements on what the law is rather than to work together with policymakers and other stakeholders to develop a balanced approach that takes into account the global nature of cryptocurrency transactions and the clear need for the US to lead the effort to provide clarity.

The Failure of SVB

Two days later, on March 10, DFPI announced that it had taken possession of SVB, a $209.026 billion[11] (as of December 31, 2022) California state member bank under the supervision of DFPI and the Federal Reserve, citing inadequate liquidity and insolvency. DFPI appointed the FDIC receiver[12] of SVB,[13] and, on the same day, the FDIC announced that to protect insured depositors,[14] the FDIC created the Deposit Insurance National Bank of Santa Clara (DINB)[15] and immediately transferred to the DINB all insured deposits of SVB. The FDIC also pointed out that all insured depositors would have full access to their insured deposits no later than March 13, and the FDIC would pay uninsured depositors an advance dividend within the next week. These uninsured depositors would receive a receivership certificate for the remaining amount of their uninsured funds and as the FDIC sells the assets of SVB, future dividend payments may be made to uninsured depositors.[16] The process of indicating that uninsured depositors may not be protected is the normal process during the appointment of the FDIC as receiver.[17] The normal process is to protect insured depositors rather than uninsured depositors.

Early reports indicate that SVB’s failure was primarily based upon bank mismanagement. In a Statement by Federal Reserve Vice Chair for Supervision Michael S. Barr[18] before the Senate Committee on Banking, Housing, and Urban Affairs on March 28, Barr laid the blame squarely on SVB’s leaders:

To begin, SVB’s failure is a textbook case of mismanagement. The bank had a concentrated business model, serving the technology and venture capital sector. It also grew exceedingly quickly, tripling in asset size between 2019 and 2022. During the early phase of the pandemic, and with the tech sector booming, SVB saw significant deposit growth. The bank invested the proceeds of these deposits in longer-term securities, to boost yield and increase its profits. However, the bank did not effectively manage the interest rate risk of those securities or develop effective interest rate risk measurement tools, models, and metrics. At the same time, the bank failed to manage the risks of its liabilities. These liabilities were largely composed of deposits from venture capital firms and the tech sector, which were highly concentrated and could be volatile. Because these companies generally do not have operating revenue, they keep large balances in banks in the form of cash deposits, to make payroll and pay operating expenses. These depositors were connected by a network of venture capital firms and other ties, and when stress began, they essentially acted together to generate a bank run. The bank waited too long to address its problems, and ironically, the overdue actions it finally took to strengthen its balance sheet sparked the uninsured depositor run that led to the bank’s failure. Specifically, on Wednesday, March 8, SVB announced that it realized a $1.8 billion loss in a sale of securities to raise liquidity and planned to raise capital during the following week. Uninsured depositors interpreted these actions as a signal that the bank was in distress. They turned their focus to the bank’s balance sheet, and they did not like what they saw. In response, social media saw a surge in talk about a run, and uninsured depositors acted quickly to flee. Depositors withdrew funds at an extraordinary rate, pulling more than $40 billion in deposits from the bank on Thursday, March 9. On Thursday evening and Friday morning, the bank communicated that they expected even greater outflows that day. The bank did not have enough cash or collateral to meet those extraordinary and rapid outflows, and on Friday, March 10, SVB failed.[19]

Concerned with the risk that a contagion may be spreading from one bank to another bank, on March 10, Secretary of the Treasury Janet L. Yellen also convened leaders from the Federal Reserve, the FDIC, and the OCC to discuss developments around SVB.[20] Based upon media reports and prudential supervisor disclosures, it appears that no national bank faced the type of stress that would have caused the OCC to intervene and take actions similar to the actions taken by DFS and DFPI.

The Failure of Signature and the Use of the Systemic Risk Exception

In addition, on March 12, New York State Superintendent of Financial Services Adrienne A. Harris announced that DFS had taken possession of Signature Bank, a $110.364 billion[21] (as of December 31, 2022) New York state nonmember bank under the supervision of DFS and the FDIC[22] in order to protect depositors. DFS also appointed the FDIC receiver.[23] On the same day, the FDIC transferred all the deposits and substantially all of the assets of Signature Bank to Signature Bridge Bank, N.A. (Signature Bridge Bank),[24] a full-service bank that was operated by the FDIC as the FDIC marketed the institution to potential bidders. The FDIC noted that the Signature Bridge Bank would open for business on March 13, and that depositors and borrowers of Signature Bank would automatically become customers of Signature Bridge Bank. The FDIC stressed that the transfer of all the deposits was completed under the systemic risk exception (SRE)[25] that allows the FDIC more flexibility and frees the FDIC from using the least costly approach when the FDIC takes over a failed bank. Under the SRE, the FDIC is authorized to insure all depositors of a bridge bank rather than insure only the deposits that were insured up to the standard maximum insurance deposit amount. Among the reasons for using the SRE was to prevent the spread of contagion that could harm other banks and to protect small businesses and not for profit corporations. The SRE, however, does not protect shareholders and certain unsecured debt holders. The FDIC also pointed out that it had replaced senior management of the failed bank.[26] On March 19, the FDIC announced[27] that it had entered into a purchase and assumption agreement for substantially all deposits and certain loan portfolios of Signature Bridge Bank with Flagstar Bank, National Association (Flagstar),[28] Hicksville, New York, a wholly owned subsidiary of New York Community Bancorp, Inc., Westbury, New York. The FDIC pointed out that depositors of Signature Bridge Bank, other than cash depositors related to the digital-asset banking businesses, will automatically become depositors of Flagstar, and all deposits assumed by Flagstar will continue to be insured by the FDIC up to the insurance limit. Flagstar’s bid did not include approximately $4 billion of deposits related to the former Signature Bank’s digital-assets banking business. The FDIC will provide these deposits directly to customers whose accounts are associated with the digital-asset banking businesses. The transaction included the purchase of about $38.4 billion of the bridge bank’s assets, including loans of $12.9 billion purchased at a discount of $2.7 billion. Approximately $60 billion in loans will remain in receivership for later disposition by the FDIC. In addition, the FDIC received equity appreciation rights in New York Community Bancorp, Inc., common stock with a potential value of up to $300 million. The FDIC estimates the cost of the failure of Signature Bank to the Deposit Insurance Fund (DIF) to be approximately $2.5 billion. The exact cost will be determined when the FDIC terminates the receivership.

The FDIC also pointed out that this was not a bailout because any losses to the DIF to support uninsured depositors will be recovered by a special assessment[29] on banks, as required by law. The FDIC, as receiver for Signature Bank, has also transferred all Qualified Financial Contracts (QFC)[30]  of the failed bank to the bridge bank. These actions will protect depositors and preserve the value of the assets and operations of Signature Bank, which may improve recoveries for creditors and the DIF. The FDIC also noted that as receiver, except where an SRE applies, the FDIC is required to operate Signature Bridge Bank to maximize the value of the institution for a future sale and to maintain banking services in the communities formerly served by Signature Bank. In this case, the bridge bank assumed the deposits and certain other liabilities and purchased certain assets of Signature Bank. The bridge bank structure was designed to “bridge” the gap between the failure of Signature Bank and the time when the FDIC can stabilize the institution and implement an orderly resolution.

Joint Actions by the Treasury, the Federal Reserve, and the FDIC

On March 12, in an attempt to calm financial markets, bank depositors, small businesses and others with more than $250,000 in a bank, and bank investors, Treasury Secretary Yellen, Federal Reserve Chair Jerome H. Powell, and FDIC Chairman Gruenberg also issued a statement[31] emphasizing that they have acted in coordination to protect the US economy by strengthening public confidence in our banking system. They also emphasized that they had obtained approval to use the SRE. “After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of SVB in a manner that fully protects all depositors…  We are also announcing a similar systemic risk exception for Signature Bank, which was closed today by its state chartering authority. Any losses to the DIF to support uninsured depositors will be recovered by a special assessment on banks, as required by law.”[32] This coordinated statement was critical and was made on a Sunday before the markets opened in Asia. The Treasury, the Federal Reserve and the FDIC and other stakeholders were worried that if such a statement were not made, then other similarly sized regional banks could fail. The statement was also important because the governmental officials wanted to send a strong message that the SRE would be used to do whatever was necessary to prevent contagion and protect the US financial system.

Also on March 12, the Federal Reserve announced[33] that it would create a Bank Term Funding Program (BTFP)[34] to support American businesses and households. Under the BTFP, the Federal Reserve will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors. The Federal Reserve announced this action was a means to provide liquidity to any bank that might experience a run on its deposits. The Federal Reserve was concerned that a number of regional banks, including several regional banks in California and other banks that used a nondiverse business model or served a large number of cryptocurrency firms, were vulnerable to bank runs on March 13. The BTFP offers loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging US Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. According to the Federal Reserve, these assets will be valued at par, and the BTFP was designed to eliminate a depository institution’s need to quickly sell high-quality securities to raise enough money to cover deposit withdrawals. Treasury also indicated that it would make available up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP.

In addition, on March 26, the FDIC announced[35] that the FDIC and First–Citizens Bank & Trust Company (First Citizens) had entered into a loss–share transaction on the commercial loans First Citizens purchased from SVB Bridge Bank.  Under the loss share transaction, the FDIC as receiver and First Citizens will share in the losses and potential recoveries on the loans covered by the loss–share agreement. The FDIC emphasized that the loss–share transaction is projected to maximize recoveries on the assets by keeping them in the private sector and the transaction is expected to minimize disruptions for loan customers.  In addition, First Citizens will assume all loan related QFCs.[36] The FDIC estimates the cost of the failure of SVB to the DIF to be approximately $20 billion, and the exact cost will be determined when the FDIC terminates the receivership.

The FSOC Meeting

Since there was still widespread uncertainty about whether the contagion would be contained, on March 12, Treasury Secretary Yellen also convened a meeting[37] of the FSOC[38]  in executive session by videoconference. In attendance at the meeting by videoconference were voting members Treasury Secretary Yellen; Federal Reserve Chair Powell; Acting Comptroller Michael J. Hsu; CFPB Director Rohit Chopra; SEC Chair Gary Gensler; FDIC Chairman Gruenberg; CFTC Chairman Rostin Behnam; and National Credit Union Administration Chairman Todd M. Harper. Also in attendance was nonvoting members Office of Financial Research Acting Director James Martin; Federal Insurance Office Director Steven Seitz; and DFS Superintendent Harris.

Joint Action by the Largest Commercial Banks

On March 16, Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo announced[39] they were each making a $5 billion uninsured deposit into First Republic. Similarly, Goldman Sachs and Morgan Stanley announced[40] that they were each making an uninsured deposit of $2.5 billion, and BNY Mellon, PNC Bank, State Street, Truist, and U.S. Bank announced they were each making an uninsured deposit of $1 billion, for a total deposit from the eleven banks of $30 billion. These banks, in consultation with Treasury and the Federal Reserve, took decisive actions to protect the financial system, and especially regional banks like First Republic.[41] These banks realized that they were unintended beneficiaries of the failure of SVB and Signature, and they essentially intended to reverse the outflows of uninsured deposits that left regional banks by returning those deposits back to the regional banks. These large banks did not want to benefit and instead wanted to protect the financial system.

Observations from the Financial Crisis

Cause or Causes of the Financial Crisis

• No one factor caused the recent financial crisis. A combination of factors caused the crisis, a combination of factors exacerbated the crisis, and a combination of factors spread the contagion. Former Federal Reserve Governor Daniel Tarullo identified four potential causes of a financial crisis, and some of these causes were likely present during the recent failures. Governor Tarullo identified four factors:
  1. Domino or spillover effects—for example, when one firm’s failure imposes debilitating losses on its counterparties. This risk is greatest when counterparty exposure is large and concentrated.
  2. Feedback loops—for example, when fire sales of assets depress market prices, thereby imposing losses on all investors holding the same asset class. The first round of losses can lead to further fire sales by affected investors who would otherwise not have sold. Another example is deleveraging—when credit is cut in response to financial losses, resulting in further losses that require a further withdrawal of credit.
  3. Contagion effects—for example, a run in which depositors, creditors, or investors suddenly withdraw their funds from a class of institutions or assets. Banks and some other financial firms, such as money market funds, are vulnerable to runs because they promise withdrawal on demand at par and their assets (e.g., loans) are less liquid than their liabilities (e.g., deposits). This creates an incentive to withdraw before other creditors/depositors do, since assets cannot be liquidated quickly enough to meet all redemption requests during a run.
  4. Disruptions to critical functions—for example, when a market can no longer operate because of a breakdown in market infrastructure. This could occur because of the failure of one firm that dominates a certain part of market infrastructure or because the infrastructure has been disrupted by, say, a cyberattack.
• Since a combination of factors caused the crisis, it is very difficult to know when the crisis actually started. While many commentators believe Silvergate started the crisis, many other commentators believe Silvergate was an exacerbating factor, and the collapse of FTX, Stable coins Terra and Luna, Celsius, Voyager Digital, and three Arrows Capital started the financial crisis.
• While the cause or causes of the crisis are uncertain, it is certain that once trust and confidence are undermined in an area of the financial system, other areas of the financial system and the financial system as a whole become vulnerable to uncertainty and lack of trust and confidence. The longer the uncertainty and lack of trust and confidence lasts, the more likely areas of the financial system and the financial system as a whole will become weakened and fragile.

Held-to-Maturity Securities

• Increasingly the discussion of the failure of SVB to manage and hedge its long-term securities is focused on whether the Financial Accounting Standards Board (FASB)[42] should review and consider changing its current accounting standards on held-to-maturity (HTM) securities[43] in light of recent advances in technology and the speed at which bank runs could occur. This is an important discussion because some commentators believe the current FASB rules allow banks to mask losses that they would have to show if they had to mark to market HTM securities. “If banks designate bonds as held-to-maturity securities, the firms are allowed to exclude unrealized losses on them from equity as long as they don’t sell. Banks have to carry HTM instruments at amortized cost, or an adjusted version of the original price they paid. Bonds the banks plan to sell need to be classified as available-for-sale securities and accounted for at fair market value. If banks sell any HTM securities, they must reclassify all of their HTM securities as available for sale and potentially take a big loss on the securities they didn’t sell.”[44]

Federal Reserve Rethink Strategy for Fighting Inflation

• The fallout from the crisis will affect monetary policy because the Federal Reserve may have to alter its inflation fighting strategy by either pausing or halting the frequency at which it increases interest rates.

Implications from the Financial Crisis

More Emphasis Placed on Core Safety and Soundness Standards

• The recent crisis provides an opportunity for prudential supervisors to take a comprehensive review of core safety and soundness issues like concentration risk; interest rate risk management; the balance between rapid growth and strong controls; and nondiverse business models. This is an important point because some policymakers have asserted that SVB would not have failed if it were subject to enhanced prudential standards set forth in the original version of Dodd Frank and its regulations implemented by the Federal Reserve. The flaw in such thinking is that concentration risk, interest rate risk and the other factors being discussed are core safety and soundness standards that all banks (even the smallest banks) are required to manage. Nonetheless, at a minimum, the prudential supervisors will reassert the importance of core safety and soundness issues by having examiners refocus on core safety and soundness issues.

The Importance of Audit

• Comments about the role of audit in identifying and flagging the problems at Silvergate, SVB and Signature in the general media have been surprisingly muted. Audit plays a critical role in forcing banks to manage the risks involved in Silvergate, SVB, and Signature. Clearly, the problems that occurred at Silvergate, SVB and Signature would normally be in the scope of the coverage of both internal and external audits. To date, it does not appear that any of the prudential supervisors have emphasized the audit failures as a cause of the problems. There is little doubt, however, that Silvergate, SVB, and Signature had major audit failures. To address those failures, the prudential supervisors will place greater emphasis on the audit function both at the management level and the board of director level. In response to the prudential supervisors, it is likely that trade associations representing auditors will enhance their audit standards to take into account the risks that brought down SVB and Signature and caused Silvergate to voluntarily liquidate.

Increase to the FDIC Insurance Maximum Amount

• There is a developing consensus in Congress that the FDIC insurance maximum amount of coverage should be increased. During the 2007/2008 financial crisis, the insurance maximum amount was increased. An increase in the maximum insurance amount to cover small businesses and not-for-profit corporations would not materially increase the risk to the DIF. Some commentators have recommended removing the cap on the insurance amount, but policymakers are likely to conclude that such a result would unreasonably increase the risk to the DIF. The more likely scenario is that the FDIC insurance maximum amount will be increased.

Expanding the Range of Enhanced Prudential Standards

• There is a consensus among federal prudential supervisors that enhanced or heightened prudential standards should now apply to banks with lower total consolidated assets than what is currently required.  These changes are likely to be made in the short term even if, in some cases, prudential supervisors will have to change their regulations after a notice and comment period in accordance with the Administrative Procedure Act. In Congressional testimony, the Federal Reserve and the FDIC have already signaled their support for making these changes and have indicated that they may be able to do so without any further action from Congress.

The Fallout from Deficient Federal Reserve Supervision

• The Federal Reserve is substantially likely to determine that the Federal Reserve’s supervision of SVB was deficient in several material respects, including, but not limited to, risk management, interest rate management, liquidity, and concentration risk. The Federal Reserve’s transition rules for moving a bank into enhanced prudential standards was a self-inflicted wound. For different reasons, the Federal Reserve’s supervision of Silvergate was also deficient. The likely consequence of this determination is that in the short-term examiners will be much more aggressive and more conservative in their findings, and supervisory offices and senior staff are likely to hold examiners to a higher standard than before to justify what might be perceived to be strong internal controls established by regulated financial institutions. This will be especially true if any of the senior examiners that worked on the SVB examination team and the Silvergate examination team receive adverse actions to their careers as the result of the SVB and Silvergate failures.

The Fallout from Deficient FDIC Supervision

• The FDIC is substantially likely to determine that the FDIC’s supervision of Signature was deficient in several material respects, including, but not limited to, risk management, interest rate management, liquidity, concentration risk, and the rapid growth of uninsured deposits. While some commentators have harshly criticized DFS for its decision to close Signature, very few commentators have criticized the FDIC. Unlike the Federal Reserve in the case of SVB and Silvergate, the FDIC is not only a prudential supervisor, but is also both an insurer and a receiver. This is a unique role in financial supervision and regulation. The FDIC was in the best position of any prudential supervisor to understand the risk of a vast imbalance of volatile uninsured deposits and yet very little has been discussed about this FDIC failure.  The likely consequence of any negative determination is that in the short-term examiners will be much more aggressive and more conservative in their findings, and supervisory offices and senior staff are likely to hold examiners to a higher standard than before to justify what might be perceived to be strong internal controls established by regulated financial institutions. This will be especially true if any of the senior examiners that worked on the Signature examination team receives adverse actions to their careers as the result of the Silvergate failure.

The Fallout from Deficient DFPI Supervision

• DFPI is substantially likely to determine that DFPI’s supervision of SVB was deficient in several material respects, including, but not limited to, risk management, interest rate management, liquidity, and concentration risk. For different reasons, DFPI should reach the same determination regarding Silvergate. While Silvergate’s resolution has been characterized as a voluntary liquidation, DFPI has not yet indicated in a public setting whether DFPI would have forced the closing of Silvergate had Silvergate not voluntarily commenced the liquidation process. DFPI and DFS are among the largest and most well resourced of the state prudential supervisors, and they are likely to be held to a higher standard by policymakers. Both of them are state supervisors for many of the most innovative regulated tech firms. It is likely that DFPI and DFS need to provide more robust supervision to these firms, especially since many of the regulated tech firms have nondiverse business models and weak internal controls. It is likely that DFPI will change its examination process, in part, based upon the failures, and, in part, based upon the changes made by the Federal Reserve and the FDIC.

OCC to Make Changes in Response to Changes by the Federal Reserve and the FDIC

• Since the federal prudential supervisors work very closely, the OCC is substantially likely to make changes to its supervision and regulation of national banks and federal savings banks in response to the changes by the Federal Reserve and the FDIC. This will be true even though no national bank or federal savings bank failed or voluntarily commenced liquidation.

Finding Banks to Provide Banking Services Will Be Harder, but Will Be Available

• One of the likely consequences of the actions taken by prudential supervisors is that some banks that provided banking services to startups and tech firms, including cryptocurrency firms, will stop doing so and some banks that were contemplating providing banking services to these firms will conclude that the risks and administrative costs of doing so are too great. This void should create an opportunity for banks that are willing to require startups, tech firms, including cryptocurrency firms, to substantially enhance their internal controls, hire independent risk managers, and use the three lines of defense approach to protect the firms. Until the SEC and the CFTC and policymakers develop and implement a workable framework for regulating these firms, prudential supervisors will likely remain unsupportive of permitting banks to offer banking services to those firms. While industry groups have asserted that self-regulation is the best approach, to date, there has not been a ground swell of support for that approach. The best and most practical approach is for banks to institute the proper controls within the banks and for banks that wish to offer banking services to those firms to require those firms to make the investment in internal controls as a condition to receiving banking services.

Federal Prudential Supervisors Do Not Trust Nondiverse Business Models or Crypto-Assets

• The prudential supervisors are reiterating the already strong, unadulterated message that banks whose business models target firms with undiversified business models (e.g., startups or crypto firms) will be held to higher prudential standards in the future.[45] The basis for this action is that prudential supervisors view these firms as high risk and prudential supervisors are unpersuaded by claims that those firms are already regulated. Prudential supervisors do not believe those firms are regulated sufficiently and believe many of those firms prefer to be unregulated or to operate under the weakest regulatory regime. This likely means that nondiverse business models and crypto-assets will remain under the microscope by examiners and the costs of operating nondiverse business models or including crypto-assets in the banking system will be even higher.

Nontraditional Financial Institutions Are Now the Focus of Other Key Governmental Agencies

• Nontraditional financial institutions are now on the radar screen of the full range of agencies that directly and indirectly regulate them. This focus will likely mean more attention is focused on financial institutions that engage in services related to crypto-assets. The Federal Trade Commission, the CFPB, state equivalents, state attorneys general, local prosecutors, and many others are now focused on protecting the public. This means nontraditional financial institutions should review and upgrade their internal controls as a means to mitigate risk and avoid government investigations or enforcement actions.

Focus on Holding Executives Accountable

• Both the Federal Reserve and the FDIC have emphasized in Congressional testimony that they have authority to hold accountable[46] those executives responsible for the SVB failure (in the case of the Federal Reserve and the FDIC) and the Signature failure (in the case of the FDIC). If enforcement actions were commenced, the Federal Reserve and the FDIC would likely first look to 12 U.S.C. 1818 to impose cease and desist orders, civil money penalties or prohibition orders. While Title II (Orderly Liquidation Authority), which was not invoked, grants the FDIC claw back authority, 12 U.S.C. 1818 does not expressly grant claw back authority. US Senator Elizabeth Warren (with a number of cosponsors) has already introduced S.1045 in the US Senate to amend the Federal Deposit Insurance Act to clarify that the FDIC and other appropriate Federal regulators have the authority to claw back certain compensation paid to executives.

Refocus on the Mix of Insured Versus Uninsured Deposits

• Much has been written about the large amounts of uninsured deposits held by SVB and Signature. Holding large amounts of uninsured deposits is not in and of itself an unsafe and unsound practice. Indeed, in many cases, there are business reasons for a bank to hold such large amounts such as to help customers with their payrolls, to hold cash security for credit extended, and for compensating balances.[47] Nonetheless, this could be an unsafe and unsound practice if the uninsured deposits are not “sticky” and the deposit holder is not loyal to the bank (e.g., the deposit holder is chasing yield or otherwise willing to move the deposit out of the bank at the first hint of dissatisfaction with the bank). Clearly, many of SVB’s large uninsured deposits were not sticky. The likely outcome of the actions of SVB uninsured deposit holders is that prudential supervisors will now require banks to monitor more closely uninsured deposits versus insured deposits and will include large withdrawals of uninsured deposits in stress test scenarios.

CFPB to Increase Emphasis on Protecting Consumers Involved in Crypto-Assets

• While the CFPB has not played much of a role in the recent financial crisis, many policymakers have called for an increased emphasis on protecting consumers involved in crypto-asset transactions,[48] and the CFPB has taken public positions regarding its intent to address these issues both through education[49] and enforcement actions.[50] Many enforcement actions are likely to be commenced based upon consumer complaints[51] the CFPB tracks very closely.