By Gretchen Morgenson -
NBC News
The recent bankruptcies of three US lenders - Signature Bank, Silicon Valley Bank and Silvergate Bank - have undermined confidence in the country's banking system.
The debacles have also put financial regulators in the dark, especially the Federal Reserve Bank of San Francisco, supervisor of Silvergate and Silicon Valley Bank.
Amid these failures, a question that loomed large during the 2008 financial crisis has resurfaced: Is the Federal Reserve (Fed), in charge of supervising the banks of which it is the main regulator, too in cahoots or aligned with them to do his job?
One factor contributing to that view is the practice of regional banks in the Federal Reserve system of inviting executives from the institutions they regulate to serve on their boards of directors.
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As of 2019, Gregory Becker, the former CEO of Silicon Valley Bank who presided over its rise and fall, was head of the San Francisco Fed.
After the bankruptcy of his bank, he was removed from the board of this body.
Lynn Turner, formerly chief accountant at the Securities and Exchange Commission, has interacted with the Fed for decades, both as an auditor and as a regulator.
“The Fed serves to protect the banks rather than serve American depositors and investors,” she explained in an interview.
"Calling the Fed 'bank supervisor' with bank executives on their boards is absolutely an oxymoron," she added.
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Silvergate, with $12 billion in deposits, and Silicon Valley Bank, with $160 billion, went under for different reasons.
But, according to analysts, the growing risks in the operations of both institutions were in sight.
Yet the Federal Reserve examiners responsible for policing them appear to have done little or nothing to correct or slow them down, analysts say.
And unlike other financial regulators, the Fed also appeared to ignore a warning it received last summer about the run-on-bank risks posed by unrestricted crypto trading.
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Silvergate shut down because it facilitated crypto transactions that became toxic after the FTX collapse;
Silicon Valley, meanwhile, was too short of cash to handle a run on depositors and was forced to sell investments at a loss.
Both risks had been well known for months and were published in regulatory filings or in statements by bank executives.
Silvergate announced this month the closure of its operations.
The Federal Deposit Insurance Corp. continues to seek buyers for Silicon Valley Bank or its assets.
Signature Bank, which was exposed to cryptocurrencies, also met the start of a rush of panicked depositors when its regulators in New York seized it on March 12.
On March 13, the Federal Reserve Board announced a review of supervision of Silicon Valley Bank.
Leading the review is Michael Barr, Vice President of Supervision, who said in a statement: "We must be humble and conduct a careful and thorough review of how we supervise and regulate this company, and what we should learn from this experience."
No review related to the Fed's supervision of Silvergate Bank has been announced.
The Federal Reserve Bank in San Francisco, California, on March 16, 2023. Justin Sullivan/Getty Images
Attempts to contact the San Francisco Federal Reserve for comment on its regulatory actions were unsuccessful.
Its media hotline was busy for several days and no email address is provided for journalists' inquiries.
The main number also does not offer a way to contact a spokesperson, and there was no response to an email sent to a general mailbox seeking comment.
Tyler Gellasch is president and CEO of Healthy Markets, an investor-focused nonprofit, and a former adviser to then-Democratic Sen. Carl Levin, who helped write the Dodd-Frank banking reforms.
Asked about the Federal Reserve's oversight of the two failing banks, he said: “There will always be bad actors and incompetent management teams, but bank regulators exist to stop them before they cause multi-billion dollar disasters.
And if the regulators can't do it on the easy stuff, what are they there for?
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Red flags were flying at both institutions, according to analysts.
At Silicon Valley Bank, the signs were a minuscule cash position available for depositors' demands: just 6% of assets, compared with 9.5% at its peer institutions, regulatory filings show.
And the bank's deposit surge - more than tripling in three years, from $57 billion to $183 billion in 2022 - should have raised questions about its management's ability to manage such growth, analysts say.
“The bottom line is that there was lax regulatory oversight of Silicon Valley operations,” Charles Peabody, a veteran banking analyst at Portales Partners LLC, wrote in a March 12 note to clients.
The loosening of surveillance was partly due to a less stringent regulatory framework for smaller institutions like Silicon Valley Bank, he concluded, and "partly due to its inept regulatory oversight body, (ie, the Federal Reserve)." .
At Silvergate, the danger centered on cryptocurrencies.
It was one of the few US banks that allowed its clients to move dollars or other fiat currencies to crypto exchanges.
Silvergate, once a sleepy San Diego industrial lending company with four branches, began the switch to cryptocurrency in 2013. Among its clients — and backers — was Sam Bankman-Fried, co-founder of crypto exchange FTX, who came to below, and its related companies.
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The FTX companies had 20 different accounts at Silvergate, according to a bankruptcy filing;
one of them was North Dimension, a company with a peculiar and apparently bogus electronics website that prosecutors say was instrumental in FTX's misappropriation of customer funds.
As a regulated institution, Silvergate was responsible for monitoring its clients' accounts for illegal activity, such as money laundering or tax evasion, and for alerting regulators to suspicious transactions.
Before initiating the shutdown, the bank told NBC News that it "performed significant due diligence on FTX and its related entities."
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However, as its extensive ties to FTX became known, Silvergate was faced with huge redemption demands from depositors.
In December, customers withdrew nearly 70% of the bank's $11.9 billion in deposits, according to a February report from the FDIC inspector general.
To meet the repayments, the bank sold $5.2 billion in debt securities it had to invest, losing $718 million in the process.
That was more than the bank had earned since 2013, according to the IG report.
Caitlin Long is the founder of Custodia Bank Inc, a special purpose depository institution in Wyoming that acts as a custodian of digital assets and only holds cash, in amounts in excess of its deposits, to meet potential redemptions.
Last summer she warned federal financial regulators, including the Fed, that bank run risks were high among institutions that serve the crypto industry.
“There was a risk of a bank run in this entire sector,” he said in an interview.
“I don't think any non-cash investment is appropriate for a bank in this sector, because, as we saw, all deposits can be withdrawn in a few seconds,” he added.
Other regulators reacted to his warning, but the Federal Reserve did not respond to it.
In January, he denied the bank's application for him to become a member of the Federal Reserve System.
The Fed said that "the company's request, as submitted, is not consistent with the factors required by law."
He also argued that the company's business model and proposed focus on digital assets presented security and robustness risks.
Long disagreed, noting that Custodia has cash backing more than 100% of its deposits.
Custody has sued the Federal Reserve in federal district court over this decision.
Existing banks with crypto operations – like Silvergate – appear to have been “passed down with no questions asked” by the Fed, Long said, “while startups seeking permission for everything we did were denied.”
In short, a perplexing paradox.
