By Jonah Crane and Patrick Haggerty
Last week, the Federal Reserve Board (Board) issued a supplement to its proposed guidelines for Federal Reserve Banks to apply when considering applications for Fed master accounts and services. The stated purpose of the guidelines is to “help foster consistent evaluation of access requests…across all twelve Reserve Banks” and “reduce the potential for forum shopping.” However, the Board appears primarily concerned about granting access to institutions with less traditional activities or “novel charters,” a category the Board describes as including cryptocurrency custody banks. An important, overarching message is that “legal eligibility does not bestow a right to obtain an account and services.”
The revised guidelines identify several core principles Reserve Banks should assess with respect to any application (as well as ongoing monitoring of institutions with master accounts). The principles mirror those initially proposed by the Board last May. Specifically, the Reserve Bank should satisfy itself that any institution granted access to payment services:
Meets legal eligibility requirements;
Would not pose excessive risks to the Reserve Bank, the payment system, the U.S. financial system, or the overall economy (including risks of illicit activity); and
Would not adversely affect the Federal Reserve’s ability to implement monetary policy.
In both the original and supplemental proposals, the Board notes that “[t]he identified factors are commonly used in the regulation and supervision of federally-insured institutions” and, as a result, applications from such institutions “will be fairly straightforward in most cases.” The supplemental guidelines expand on this concept by proposing a tiered framework for reviewing applications based on the regulatory status of the applicant:
Tier 1: Insured depositories would benefit from a “less intensive and more streamlined review,” because they are subject to a comprehensive regulatory regime.
Tier 2: Uninsured banks subject (by statute) to federal prudential supervision and subject to Fed supervision at the parent level (by statute or commitment) will generally receive an intermediate level of scrutiny, because they may pose greater risks than Tier 1 institutions.
Tier 3: Uninsured institutions not subject to federal prudential supervision at the institution or holding company level would be subject to the most stringent review.
The tiered review framework puts traditional insured depository institutions at a distinct advantage to other legally eligible institutions. Tier 1 excludes federally-regulated institutions, such as national trust banks, that are not typically insured or subject to consolidated prudential supervision but many of which have long had Federal Reserve master accounts. Interestingly, industrial loan companies (ILCs), many of which have long maintained a Federal Reserve master account, appear to qualify under Tier 1 despite the absence of holding company supervision. Although the FDIC recently implemented rules that strengthen oversight of ILC parent companies, the specific requirements imposed on the ILC parent by contract under those rules fall well short of consolidated supervision under the BHCA.
Tier 2 appears to be limited to uninsured but legally-eligible institutions that are willing to agree, presumably contractually, to allow the Federal Reserve to exercise BHCA-like supervision over otherwise exempt organizations. Legally-eligible institutions with statutory federal banking supervision, such as national trust banks, would have to balance the benefits of seeking a Federal Reserve master account under Tier 2 (relative to Tier 3) with the apparent condition that they agree to consolidated supervision, which is not legally required.
Depending on how these conditions are applied in practice, few institutions may qualify for Tier 2 review. For example, uninsured state banks, such as state trust companies or Wyoming special purpose banks, would generally not qualify for Tier 2 as they do not have a federal prudential supervisor. If eligible, these institutions may seek to become Federal Reserve member banks and commit to holding company supervision in order to receive Tier 2 treatment. Companies will have to decide whether a potentially easier path to master account access is worth the tradeoff of consolidated supervision.
All other legally-eligible institutions, including a significant number with existing Federal Reserve master accounts, would be evaluated under the still-to-be-defined criteria under Tier 3. The extent to which each Federal Reserve Bank exercises its discretion to increase or decrease the differences between Tier 1 and Tier 3 will largely define the extent to which access to the Fed payments systems, now and in the future, is limited in practice to insured depositories.
The revised guidelines reflect several policy considerations that regulators have recently been grappling with in other contexts.
The emphasis the guidelines place on consolidated prudential supervision mirrors the policy views expressed by Acting Comptroller Mike Hsu. Hsu has indicated that, going forward, national banks engaged in cryptocurrency activities will be required to be subject to consolidated prudential supervision. This raises the question: how might the Federal Reserve respond to applications by Anchorage, Protego, or Paxos, all of whom have been approved (conditionally, in the case of Protego and Paxos) for national trust charters but none of whom have formed a bank holding company?
The Board is also concerned about its ability to use reserve requirements to implement monetary policy, which may be more limited for banks that don’t engage in significant lending activities or that aren’t constrained by leverage capital ratios.
The proposal suggests some potential solutions to the identified policy concerns. In particular, the Fed indicates it may impose a cap on balances held in a master account, pay a different rate of interest on balances held in the account, or limit the amount of balances in an account that receive interest. These proposals may point the way forward for the design of a potential CBDC and Fed consideration of applications for master accounts by stablecoin operators, as similar policy concerns have been raised in those contexts. All non-traditional applicants should engage the Fed with a keen awareness of the policy concerns motivating the guidelines.
Image Source: Rafael Saldaña via Flickr.