Great Depression depositors cashed out to avoid the effects of bad bank lending; now they are running into trouble first
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When US banks fell like dominoes in the Great Depression, the cause was often a classic run: depositors withdrew cash en masse amid fear of lenders amassing huge losses on bad loans and investments.
The cryptocurrency era just put a new twist on that with the depositors running into trouble first.
Silvergate Capital, a California lender that offers digital-asset ventures a place to park their cash, jolted shareholders on Thursday in saying that it recently survived an $8.1bn drawdown on deposits. That’s roughly 70%, even more severe than runs seen in the Depression. But in this case, the bad betting was done by the depositors themselves, a roster of crypto entities including parts of Sam Bankman-Fried’s doomed FTX empire. 
“This is unprecedented, it’s very unusual,” said Karen Petrou, a managing partner at Federal Financial Analytics, a Washington research firm. “Because they were so dependent on crypto funding, they were vulnerable for a run. Given the crypto market has been unstable, they got it.”
Bank regulators, she said, will take a closer look at such situations.
Indeed, earlier this week the Federal Reserve, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency issued an unusual warning to banks that deal with crypto firms, expressing concern about business models that are too concentrated in crypto-related activities.
“It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system,” said the regulators.
Silvergate expressed confidence in its liquidity and ability to move on, a notion supported by several Wall Street analysts. But Silvergate’s disclosure, and its selling of assets at a loss to raise cash, sent its stock tumbling, bringing its total slide to more than 90% since the end of 2021, the year bitcoin hit a record high.
In other modern bank crises, such as the 2008 credit crunch that claimed Bear Stearns and Lehman Brothers, problems began as souring loans and other assets chewed holes in lenders’ balance sheets. As those losses mounted, funding sources panicked and pulled away.
Selling assets
But in Silvergate’s case, the firm made relatively few loans. Regulatory filings show the vast majority of its $15.5bn balance sheet at the end of September consisted of securities issued or backed by the US government or municipalities, which are generally considered relatively safe and easy to unload.
Instead, the pressure started on the other side of Silvergate’s balance sheet. Almost 94% of the firm’s liabilities were deposits, with about $11.9bn from digital-asset customers. That figure plunged to $3.8bn by the end of the fourth quarter. 
To keep up with outflows, Silvergate had to sell nearly half of its securities portfolio, liquidating $5.2bn of debt securities for cash. In that rush, it incurred $718m in losses. The firm said it expects more hits as it sells securities to reduce its $6.7bn in wholesale borrowings.
Spurring the flight of customers was the collapse of Bankman-Fried’s FTX exchange operator and his Alameda Research investment firm amid allegations that they had covered up billions of dollars in losses. That rattled public confidence, sent prices of digital assets tumbling and cost FTX customers and crypto investors around the world. Bankman-Fried has pleaded not guilty to fraud charges. 
A huge pause
Amid the turmoil, some institutional clients pulled deposits from Silvergate accounts and switched to less risky positions, taking a “huge pause” from crypto, Silvergate CEO Alan Lane said on a call with analysts. 
“We had clients that were proprietary traders, market makers that had been doing business with each other for sometimes six to eight years,” said the firm’s president, Ben Reynolds. “They just stopped doing business with each other, and essentially pulled out all their deposits.” 
Some clients desperately needed whatever cash they could muster to make ends meet. By year-end, about $150m of Silvergate’s deposits came from clients in bankruptcy proceedings, the bank said.
FTX represented less than 10% of the bank’s deposits. The US government is seizing assets kept in Silvergate bank accounts tied to one of FTX’s units. 
“No bank should be concentrated in one industry,” said Todd Baker, senior fellow at the Columbia Business School and Columbia Law School and a former chief strategy officer at three large banks. Silvergate will come under “significant regulatory pressure to diversity its business”.
Bloomberg News. More stories like this are available on bloomberg.com
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