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Analysts Question Fed's Oversight After Bank Failures

S.J. Steinhardt
Published Date:
Mar 22, 2023

iStock-487808414 Federal Reserve Washington DC

After the recent failures of Silicon Valley, Signature and Silvergate Banks, some analysts have called the Federal Reserve Board’s ability to supervise the banking system into question, reported.

One issue, which first emerged during 2008-09 financial crisis, is prompted by the fact that executives of regional banks in the Federal Reserve system sit on the boards of the institutions that they are charged with regulating.

A recent example is that of Gregory Becker, who served as Silicon Valley Bank’s final CEO as well as a director of the San Francisco Fed until his bank collapsed and he was removed from the San Francisco Fed board.

“The Fed serves to protect the banks rather than serving the American depositors and investors,” Lynn Turner, a former Securities and Exchange Commission (SEC) chief accountant, told NBC News. “To call the Fed a ‘bank supervisor’ with bank executives on their boards is absolutely an oxymoron.”

Both Silvergate’s and Silicon Valley’s operational risks were apparent, but Fed examiners did little or nothing about them, analysts told NBC News. The Fed also seemed to disregard a warning it got last summer about risks of bank runs posed by ill-equipped banks such as those two. Such risks had been publicized either in regulatory filings or in statements made by the banks’ executives. 

Announcing a review of the supervision of Silicon Valley Bank last week, Fed Board Vice Chair for Supervision Michael Barr said: “We need to have humility and conduct a careful and thorough review of how we supervised and regulated this firm, and what we should learn from this experience.” NBC News noted that no such review of the Fed’s oversight of Silvergate Bank has been announced.

“There will always be bad actors and incompetent management teams, but banking regulators exist to stop them before they make multibillion-dollar messes,” Tyler Gellasch, president and CEO of Healthy Markets, an investor-focused nonprofit organization, told NBC News. Gellasch also served as counsel for then-Sen. Carl Levin (D-Mich.), who helped to draft the Dodd-Frank banking reforms. “And if the regulators can’t do that on the easy stuff, then what are they there for?”

Analysts told NBC News that many of the banks’ management should have aroused regulatory interest. Silicon Valley had a small cash position available for depositor demands, and it tripled its deposits in three years, from $57 billion to $183 billion in 2022, which should have alerted regulators to look into its management’s ability to handle such growth.

“The bottom line is that there was a lax regulatory oversight of Silicon Valley’s operations,” Portales Partners LLC bank analyst Charles Peabody, wrote in a March 12 note to clients, in which he called the Fed an “inept regulatory oversight body.”

Silvergate, which began the switch to crypto in 2013, had Sam Bankman-Fried, a co-founder of FTX, as a client and promoter. FTX companies held 20 different accounts at Silvergate, according to a bankruptcy filing reported by NBC News. One was a company that played a central role in FTX’s misappropriation of customers’ funds. 

Regulated institutions such as Silvergate are responsible for monitoring their clients’ accounts for illegal activities, such as money laundering or tax evasion, and alerting regulators to suspicious transactions. Once depositors learned of the bank’s ties to the now-discredited FTX, a run commenced, with almost 70 percent of the bank’s $11.9 billion in deposits withdrawn in December. The bank sold $5.2 billion in debt securities that it held for investment, losing $718 million in the process—more than the bank had earned since 2013, according to a Federal Deposit Insurance Corporation (FDIC) Inspector-General report

“There was bank run risk all over this industry,” said Caitlin Long, the founder of Custodia Bank Inc., a special purpose depository institution that acts as custodian of digital assets and holds only cash, in amounts that exceed its deposits, to meet possible redemptions, NBC News reported. “I don’t think any investment other than cash is appropriate for a bank in this sector, because, as we saw, all the deposits can be withdrawn in a few seconds.”

She told NBC News that she warned federal financial regulators, including the Fed, that the risks of bank runs were high among institutions serving the crypto industry last summer, and that the Fed did not respond to her.