As lawmakers probe one bank’s crypto dealings and use of housing-focused funding amid a deposit run last year, others in Washington are putting the spotlight on the Federal Deposit Insurance Corp.
Policy advocates say a 2020 change to the FDIC’s rules around brokered deposits opened the door for San Diego-based Silvergate and others to load up on deposits from crypto firms without taking precautions to protect themselves against volatility.
Silvergate, a leading financial service provider for the crypto industry, saw $8.1 billion of deposit drawdowns during the fourth quarter of last year as the crypto exchange FTX collapsed and triggered widespread volatility in the digital currency market. To stave off a liquidity crisis, the bank tapped the Federal Home Loan Bank of San Francisco for a $4.3 billion advance, a move that has drawn questions from both Democrats and Republicans on the Senate Banking Committee.
The bank also doubled its holdings of brokered deposits 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 brokered deposits were not the root of the bank’s issues.
“I have no special knowledge of Silvergate’s capital structure, but it is clear that Silvergate’s deposit outflows were the result of core customer withdrawals, not brokered deposits — Silvergate’s brokered deposit balances increased in Q4 even as its overall deposits fell by 70 percent,” Brooks wrote in an email this week. “Any suggestion that brokered deposits caused the Silvergate liquidity situation thus appears to have things backward.”
Yet, skeptics say the question is not about which of the $6.9 billion of lost deposits are considered brokered, but rather those which would have been under the FDIC’s prior regime.
“What seems to have happened with Silvergate is that a very large portion of its deposits were these formerly brokered, now not brokered, deposits from crypto,” Todd Phillips, an independent consultant and former FDIC lawyer, said. “If those crypto firms’ deposits were still considered brokered, Silvergate couldn’t have as much as it did.”
A spokesperson for Silvergate declined to comment for this article.
Brokered deposits are deposits collected from individual customers by a third party and deposited in a bank as a single block. For decades, the FDIC has placed restrictions around brokered deposits, also known as “hot deposits,” because of their proclivity to come and go with little notice.
Historically, the primary concern around brokered deposits has been their proclivity 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 thrifts offered competing high interest rates to entice brokers, only to see them move onto the next highest bidder.
To curb this activity, regulators placed restrictions on brokered deposits, such as blocking undercapitalized banks from accessing them and requiring institutions to hold more liquid assets to offset potential losses. Brokered deposits also elicit greater supervisory scrutiny and can require banks to pay higher premiums on their deposit insurance.
Silvergate remained “well capitalized” despite its significant drawdowns and $1 billion of disclosed losses, according to its latest quarterly earnings report, meaning it would not have been prohibited from accepting brokered deposits. But doing so would have been more costly than core deposits.
Phillips said even if Silvergate’s deposit outflows were not driven by third-party deposit collectors, the fact that those types of groups could be treated the same as individual bank customers raises concerns that warrant another look by the FDIC.
“In light of the crypto collapse and the fact that there are so many crypto firms that have relationships with individual banks, it is vitally important for the FDIC to revisit this rule and bring those deposits back under the definition of brokered deposit,” he said.
In 2020, the FDIC made several amendments to its policy on brokered deposits with an eye toward modernizing them for the digital age. These included a broader set of options for third-party deposit collectors to avoid being treated as brokers. Many of these exceptions do not require FDIC approval, firms simply have to notify the agency that they meet the criteria. Others require no disclosure at all.
At the time, then-FDIC board member Martin Gruenberg — now the chair of the agency — voted against the rule change and voiced concerns that it would expose the banking sector to greater risks. He said the new regime provided too many loopholes for entities that should be deemed brokers to avoid regulatory scrutiny.
“Under this change, a bank could rely for 100% of its deposits on a sophisticated, unaffiliated third party without any of those deposits considered brokered,” Gruenberg said at the time. “A bank could form multiple ‘exclusive’ third-party relationships to fund itself without any of those deposits considered brokered.”
Because the exceptions were aimed at firms that established exclusive relationships with banks — as many crypto firms and fintechs have done — policy skeptics feel the amendment was a giveaway to the unregulated sectors at the expense of banking sector stability.
“Too many regulators, especially in the Trump years, fell in love with the cryptocurrency industry far too fast, perhaps because they had dollar signs – or maybe bitcoin signs – in their eyes,” Carter Dougherty, a spokesman for the advocacy group Americans for Financial Reform, said. “Regardless of their motivation, the crypto crash has underscored the need to protect the integrity of our banking system, not allow a pretend financial system into the real one.”
Brooks, now CEO of Bitfury, a security and infrastructure company that serves the Bitcoin blockchain, is viewed as a key architect for the FDIC’s 2020 brokered deposit reforms. But he pushes back against the notion, saying the agency’s effort to update its policy predated his time in government, which began in May 2020 and ended in Jan. 2021.
“The FDIC commenced work on modernizing its brokered-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 board majority.”