As lawmakers investigate a bank’s cryptocurrency transactions and use of funds focused on housing amid a run on deposits last year, others in Washington are turning the spotlight on the Federal Deposit Insurance Corporation.
Proponents of the policy say a 2020 change to the FDIC’s rules on traded deposits opened the door for San Diego-based Silvergate and others to charge into crypto firms’ deposits without taking precautions to protect themselves. against volatility.
Silvergate, a leading provider of financial services to the cryptocurrency industry, raised $8.1 billion from deposit withdrawals during the fourth quarter of last year when crypto exchange FTX crashed, causing widespread volatility in the digital currency market. To avoid a liquidity crisis, the bank struck Federal Home Loan Bank of San Francisco for an advance of $4.3 billion, a move that has drawn questions both Democrats and Republicans on the Senate Banking Committee.
The bank also doubled its trading deposit holdings from $1.2 billion in the third quarter of last year to $2.4 billion in the fourth quarter, according to quarterly earnings reports. Former acting comptroller of the currency Brian Brooks pointed to this as evidence that traded deposits were not the root of the bank’s problems.
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“I have no special knowledge of Silvergate’s capital structure, but it is clear that Silvergate’s deposit outflows were the result of major customer withdrawals, not traded deposits: Silvergate’s traded deposit balances increased in the fourth quarter even as their total deposits dropped 70 percent,” Brooks wrote in an email this week. “Any suggestion that traded deposits caused Silvergate’s liquidity situation seems to have the tables turned.”
However, skeptics say the question is not which of the $6.9 billion in lost deposits are considered traded, but which would have been under the previous FDIC regime.
“What appears to have happened with Silvergate is that a large portion of their deposits were formerly traded, now non-traded cryptocurrency deposits,” said Todd Phillips, an independent consultant and former FDIC attorney. “If the deposits of those crypto companies were still considered traded, Silvergate wouldn’t be able to hold as much as it did.”
A Silvergate spokesperson declined to comment for this article.
Traded deposits are deposits collected from individual customers by a third party and deposited with a bank as a single block. For decades, the FDIC has placed restrictions on negotiated deposits, also known as “hot deposits,” because of their tendency to come and go with little notice.
Historically, the main concern around traded deposits has been their propensity to leave in search of more favorable interest rates at another bank. This pattern first became problematic during the run-up to the savings and loan crisis, when troubled savings banks offered competitive high interest rates to entice brokers, only to see them move on to the next highest bidder.
To curb this activity, regulators have imposed restrictions on traded deposits, such as blocking access to undercapitalized banks and requiring institutions to hold more liquid assets to offset potential losses. Traded deposits also trigger increased supervisory scrutiny and may require banks to pay higher premiums for their deposit insurance.
Silvergate remained “well capitalized” despite its significant withdrawals and $1 billion of disclosed losses, according to its latest quarterly earnings report, meaning it would not have been barred from accepting deposits from brokers. But doing so would have been more expensive than basic deposits.
Phillips said that even if Silvergate’s deposit outflows were not driven by third-party deposit collectors, the fact that such groups may be treated the same as individual bank customers raises concerns that warrant another review by the FDIC. .
“In light of the cryptocurrency crash and the fact that there are so many cryptocurrency firms that have relationships with individual banks, it is critically important that the FDIC review this rule and bring those deposits back into the definition of a traded deposit,” said. .
In 2020, the FDIC made several changes to its policy on traded deposits to modernize them for the digital age. These included a broader set of options for third-party deposit collectors to avoid being treated as a broker. Many of these exceptions do not require FDIC approval, companies simply must notify the agency that they meet the criteria. Others do not require any disclosure at all.
At the time, then-FDIC board member Martin Gruenberg, now the chair from the agency- voted against the rule change and expressed concern that it would expose the banking sector to greater risks. He said the new regime provided too many loopholes for entities that should be considered brokers to avoid regulatory scrutiny.
“Under this change, a bank could trust 100% of its deposits to a sophisticated, unaffiliated third party without any of those deposits being considered traded,” Gruenberg said at the time. “A bank could form multiple ‘exclusive’ relationships with third parties to fund itself without any of those deposits being considered traded.”
Because the exceptions were targeted at companies that established exclusive relationships with banks, as many crypto firms and fintechs have done, policy skeptics feel the amendment was a gift to unregulated sectors at the expense of the stability of the banking sector.
“Too many regulators, especially in the Trump years, fell in love with the cryptocurrency industry too quickly, perhaps because they had dollar signs, or maybe bitcoin signs, in their eyes,” said Carter Dougherty, a spokesman for the think tank. defense Americans for. Financial Reform, he said. “Regardless of its motivation, the cryptocurrency crash has underscored the need to protect the integrity of our banking system, not allow a fictional financial system to become a real one.”
Brooks, now chief executive of Bitfury, a security and infrastructure company that services the Bitcoin blockchain, is seen as a key architect for the FDIC’s 2020 negotiated deposit reforms. But he dismisses the idea, saying the agency’s effort to update its policy predates his time in government, which began in May 2020 and ended in January 2021.
“The FDIC began work on modernizing its negotiated deposit rule in 2018, long before I joined the OCC,” he said. “I was proud to support the FDIC’s rule changes, which were adopted by a 3-1 majority on the board.”
