In the fourth quarter of 2022, Silvergate Bank, a $16 billion California bank with a concentration in the crypto industry, experienced a depositor run after the crypto firm FTX collapsed. In total, nearly 70 percent of the bank’s deposits fled in that quarter, totaling $8.1 billion.
The situation bore a strong resemblance to the runs that brought down SVB and Signature Bank the following March. In addition to its exposure to the crypto industry, the bank was poorly managed, experienced significant losses on longer-term securities and had concentrated funding (see here). The outcome was different, however, because Silvergate was prepared to borrow from the discount window. The bank borrowed $4.5 billion from the San Francisco Fed in addition to $4.3 billion from FHLB San Francisco.
The details of the discount window borrowing were revealed by the Fed’s quarterly discount window disclosure (available here). On Nov. 15, 2022, as FTX was collapsing, Silvergate conducted a $10,000 test loan backed by municipal securities with $2.7 billion in lendable value and other securities with $229 million in lendable value. On Nov. 16, the bank pledged an additional $26 million in Treasuries and $1.9 billion in agency MBS and borrowed $4 billion. On Nov. 17, it borrowed $4.5 billion. Borrowing remained at that level through the end of the month after which it was wound down. The borrowing was fully repaid by Dec. 15, 2022.
As the borrowing amount declined, so too did the amount of securities that the bank pledged to the San Francisco Fed as collateral. According to the bank’s Call Report, over the quarter, the bank’s securities portfolio declined by $5.7 billion. The bank therefore likely repaid its discount window loan by selling securities.
Despite weathering the run, Silvergate’s troubles continued, and on March 8, 2023, it announced that it would self-liquidate. The bank repaid all its depositors, and there was no loss to the FDIC.
The next day, on Friday, March 9, 2023, Silicon Valley Bank closed its doors in the teeth of a massive run. The run was sparked in large part by SVB’s rapid sale two days before of a large part of its securities portfolio to raise liquidity, realizing substantial losses. As the run materialized, SVB attempted to shift collateral to the discount window, but was unable to do so in time. Signature Bank, which was closed over the weekend, encountered similar difficulties. Since Silvergate Bank conducted a test borrowing in the prior quarter, it was able to ensure it was able to tap the window when needed; however, neither SVB nor Signature Bank had done so. To stem a broader run on the banking system, the Treasury, Fed and FDIC invoked the systemic risk exception to least cost resolution to enable the FDIC to bail out the uninsured depositors of the closed banks.
In short, the discount window operated in exactly its intended manner in the case of Silvergate, preventing a disorderly failure.[1] Had SVB and Signature been prepared to borrow, they too could potentially have been wound down safely, obviating a government bailout.
Despite the clear benefits of being prepared to borrow from the discount window, banking regulations still do not recognize that a bank that is prepared to borrow is more liquid than one that is not. The regulations thereby miss an opportunity to give banks an incentive to be prepared to borrow. Moreover, they reinforce the message that borrowing is wrong, contributing to the substantial stigma associated with borrowing.
The Fed has recently taken some constructive steps. It has sought input from stakeholders on how discount operations can be improved. BPI’s response emphasized the importance of being able to move collateral to the window rapidly. In addition, The Fed published an FAQ in August that stated that banks are now allowed to point to the discount window in their required internal liquidity stress tests as the means by which they would monetize their liquid assets. A recent BPI survey found that the FAQ had been an effective step in reducing, albeit far from eliminating, stigma.
Nevertheless, a bank with prepositioned collateral at the Fed is still not allowed to count on the window as a source of liquidity in its internal tests, nor does the capacity count toward the bank’s liquidity coverage ratio. Banks are also not allowed to count on the window as a source of liquidity in resolution for more than a few days.
[1] The discount window also has a separate, monetary policy function.
