Silvergate Bank, the La Jolla based bank that made a name for itself by specializing in providing banking services to the crypto industry, has recently come under scrutiny for using a (quasi) federal lending program, designed to make mortgages more affordable, to meet the storm of withdrawals that occurred shortly after FTX collapsed. Silvergate customers withdrew $8.1 billion in the fourth quarter of 2022, roughly 70% of Silvergate’s deposits. Silvergate was able to meet the outflow, in part, by securing $4.3 billion in loans from the Federal Home Loan Bank (FHLB) of San Francisco. Silvergate posted an almost billion dollar loss for the fourth quarter of 2022.
The FHLB system was created under Herbert Hoover in 1932 with the primary goal of making homeownership more affordable for the average American. One method for achieving this goal was to create FHLBs and allow them to provide secured loans (so called “advances”) to their member banks (which includes Silvergate) so member banks could create mortgages at lower rates. While long-term advances by the FHLBs are generally restricted to funding residential housing financing, short-term advances have no such restrictions. This permitted Silvergate to secure funds from the FHLB to satisfy the frenzy of withdrawals it experienced during the 4th quarter. While FHLBs are privately capitalized, they enjoy a special statutory lien priority which can place them ahead of other parties, including the FDIC, in bankruptcy proceedings. Thus, if Silvergate were to join the spate of major crypto industry entities that filed bankruptcy recently, it could leave the FDIC holding the (empty) bag, responsible for paying out deposit insurance on Silvergate’s FDIC insured accounts while the FHLB is first in line for any assets remaining.
The crypto industry has largely been believed to be siloed off from more traditional financial arenas. Some federal regulators seem keen on keeping it that way. Earlier this month federal banking regulators warned banks of the risks associated with dealing in crypto-assets and crypto-asset participants. The advances Silvergate received from the FHLB are a clear indication that the lines are blurring and crypto is bleeding into traditional financial channels. Given that and the current climate surrounding the crypto industry, it seems likely that federal law makers and regulators will be further emboldened to pursue more extensive oversight and regulation of the industry.