Early Investing

Where Silvergate, SVB and Signature Went Wrong

Where Silvergate, SVB and Signature Went Wrong
By Vin Narayanan
Date March 17, 2023

For people my age, Han Solo telling Luke Skywalker “Great, kid! Don’t get cocky!” after Luke shot down a ship for the first time is a seminal movie moment. As a kid, I didn’t even know what “cocky” meant! But I knew the line was hilarious. I repeated it over and over again — no doubt annoying everyone around me.

I really wish some bank executives had listened to Han Solo. If they had, we might not have had the bank runs we saw over the past several days. And we wouldn’t be worried about crypto’s banking problem.

One of the ironies of the crypto industry is that it needs banking partners. Think about it. Crypto is designed to disrupt money and banking as we know it. But to operate right now, crypto companies need banks. Crypto exchanges need banks to hold onto the cash their customers deposit to buy and sell crypto. Crypto startups need banks to handle payroll, rent, vendors and the many other services needed to run a business. Crypto venture capitalists need banks to hold onto their money so they can invest it. But because the U.S. government has been telling banks to avoid the crypto sector, only a few banks have chosen to work with the crypto sector. Silvergate and Signature were two of those banks. Both banks (along with Silicon Valley Bank) got a little cocky. And now they’re paying the price.

Silvergate was making tons of money being a crypto bank. In fact, it was making so much money banking the crypto sector that it didn’t bother to diversify its client base. Oops. Here’s how the Silvergate bank run played out. First, it took much of the money that had been deposited and parked it in traditionally safe investments like Treasury notes, mortgage-backed securities, and municipal bonds. The goal was to generate some income off of the money that it was just holding onto. There’s nothing wrong with that. And these investments are generally not risky. 

But then the Federal Reserve started raising interest rates to fight off inflation and Silvergate’s assets dropped in value. Uh-oh. Then the FTX debacle combined with a crypto bear market and a tech recession prompted Silvergate customers to withdraw money. And they kept withdrawing. And all of sudden, Silvergate didn’t have enough cash or assets (even if it sold them) to cover the withdrawals. 

If Silvergate had a wide range of clients, the FTX debacle and crypto markets wouldn’t have prompted a bank run. Insurance companies, retail stores and small businesses had no reason to run out and withdraw their money. But because it hadn’t diversified its customer base enough — AND it hadn’t figured out how to manage the Fed rate hikes — a bank run ensued. 

The same thing happened to Silicon Valley Bank (SVB). Most of SVB’s clients were in the tech industry. The tech industry is getting hammered. If SVB had diversified its client base, there likely wouldn’t have been a bank run. But SVB got cocky. It was living the big life as the tech industry boomed. And it didn’t de-risk its customer base.

Signature’s crypto risk was much smaller than Silvergate’s. It had a diverse client base. But the government still closed it because of the potential of “systemic risk.” In many ways, Signature is a victim of circumstances. People became worried about smaller regional banks. That triggered withdrawals. The government didn’t want another bank to go under. That combined with Signature’s small crypto business — which the government is not happy about — prompted the closure.

Signature underestimated how much the government disliked the fact that it had crypto clients — and the rapid spread of the bank runs to a lesser degree. It got a little cocky. And it paid the price.

All of this should serve as a wake-up call to all banks. They can’t afford to get cocky — especially with rates rising and inflation being out of control. They need to actively manage risk and ensure that they’re well capitalized. It’s not a passive activity anymore. And banks need to act accordingly.

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