Will FTX Turn Into a Regulatory Headache for Silvergate Capital or Signature Bank?

Silvergate Capital (SI 16.75%) and Signature Bank (SBNY 1.03%) are the two main federally insured banks serving the crypto industry.

Both have developed real-time payments networks that crypto exchanges and crypto institutional traders can use to exchange U.S. dollars in real time, essentially serving as a fiat on-ramp for the crypto industry.

But with Silvergate and Signature having served the large crypto exchange FTX before it filed for bankruptcy, there has been lots of chatter over whether these two banks could face regulatory consent orders or fines. Will FTX turn into a major regulatory headache for either of these banks? Let’s take a look.

What the regulatory issues could be

As many now know, one thing FTX is being accused of is using customer funds to prop up its sister firm Alameda Research after the hedge fund made a series of bad investments. So a big question has been whether Silvergate or Signature should have flagged any transactions or reported suspicious activity regarding FTX. And for all we know, the banks might have very well filed suspicious activity reports (SARs) or flagged irregular activity. Banks by law are not permitted to disclose whether they did this.

However, if either of these banks saw some irregular transfers or activity and did not report it correctly, they could be in violation of bank anti-money laundering (AML), Bank Secrecy Act (BSA), or know your customer (KYC) rules. This is currently a central argument being made by many short sellers of Silvergate and Signature.

Interestingly, though, the management teams of both Silvergate and Signature were asked by analysts on their fourth-quarter earnings calls about possible regulatory problems due to FTX, and the banks had varying answers.

Depends on whom you ask

Signature Bank has said very little about its crypto activities in the past. But on its recent earnings call, Chief Executive Officer Joseph DePaula said:

With the FTX, it wasn’t a matter of BSA/AML. Everyone thought that he [Sam Bankman-Fried] was legitimate and he ended up being very [Bernie] Madoff-like. So, I don’t think anyone could say that they knew that and we catch it.

Later on in the earnings call, Signature Bank Chief Operating Officer Eric Howell took it a step further, adding:

You know, we had announced that we’re integrating FTX, but we were not integrated yet with FTX. So we didn’t have client-related transactions of FTX happening on our platform. Yeah, so, that’s certainly good.

This is definitely important, because if FTX made no transactions on Signature’s Signet platform, the bank has a much better chance of avoiding regulatory difficulties. A few months ago, Signature reported having only 0.1% of its total deposits from FTX specifically.

On Silvergate’s earnings call, there was a much smaller discussion on the matter, as management simply didn’t comment when asked about regulatory issues.

Silvergate is a much smaller bank than Signature and operates pretty much only in the crypto banking market, whereas Signature has many other lines of business and gets deposits from a range of other sources.

Silvergate had also been doing business with FTX for much longer and also had Alameda Research as a client. Nearly 10% of the bank’s digital-asset-related deposits at Silvergate were tied to FTX, and the bank actually featured a quote from Bankman-Fried on its website before the scandal.

Is either bank in trouble?

Based on the information available, I think it’s more likely that Silvergate will face trouble from regulators than Signature, but it’s possible neither will.

As a highly regulated bank, Silvergate has three regulators and must have AML, BSA, and KYC protocols and programs in place. I find it hard to believe that regulators weren’t watching Silvergate closely. Also consider that the bank was growing extremely fast during the pandemic and that it was heavily involved in crypto.

Regulators also approved Silvergate’s acquisition of the Diem stablecoin technology from Meta Platforms in early 2022, and banks usually have to be in good standing with regulators to make acquisitions.

Silvergate could certainly face some kind of regulatory action here, but only time will tell if there is a consent order or a hefty fine. Ultimately, I believe Silvergate is at greater risk than Signature.