Fed Issues Guide On Crypto Firms Access To Pay System

August 17, 2022
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The US Federal Reserve has finalised guidelines aimed at helping regional banks evaluate requests by crypto firms to connect to the central bank payment system. The guidelines are expected to provide much-needed clarity on the process, rebuked by some as a “black box”.

The US Federal Reserve has finalised guidelines aimed at helping regional banks evaluate requests by crypto firms to connect to the central bank payment system. The guidelines are expected to provide much-needed clarity on the process, rebuked by some as a “black box”.

Earlier this week (August 15), the Federal Reserve Board (FRB) released final guidelines that establish a long-awaited transparent process for regional reserve banks when they review requests to access federal reserve accounts.

"The new guidelines provide a consistent and transparent process to evaluate requests for Federal Reserve accounts and access to payment services in order to support a safe, inclusive, and innovative payment system," said vice chair Lael Brainard.

A federal reserve account, or master account, is a settlement account that allows institutions to settle their Fed financial services transactions directly with a reserve bank.

Firms can also participate indirectly using the master account of another institution that has agreed to act as a correspondent bank, but direct participation is typically less costly and opens up a wide range of additional Fed functions.

Although typically banks apply for master accounts, in recent years the central bank has noticed an increase in the number of applications by “novel” firms, such as fintechs and crypto firms.

The issue became particularly pressing in 2020, when Kraken and Custodia, the first crypto firms to receive a state bank charter in Wyoming, filed an application to the Kansas Fed seeking a master account.

While the Kansas Fed was reviewing the applications, last May, the FRB stepped in, proposing guidelines to ensure that these requests are evaluated in a consistent and transparent manner across the federal reserve system.

A black-box process

News that the Federal Reserve has finalised its guidelines will be welcomed by a number of critics who have challenged its process of approving applications.

In February, Republican Senator Pat Toomey (R-PA) uncovered that Sarah Bloom Raskin, President Joe Biden’s former pick for the Fed’s vice chair for supervision, may have influenced the Kansas Fed to grant a fintech firm a master account.

Raskin, who served on the board of Reserve Trust, apparently called the Kansas Fed president and successfully lobbied for a favourable decision on the fintech firm’s application. Reserve Trust therefore became the first ever fintech in the US to get access to a Fed master account as a result of Raskin’s intervention, according to the senator.

Since the scandal broke, Toomey has pushed the Kansas Fed and the FRB to reveal the details of the review but the agencies have refused to provide the senator with the requested documents.

In a June Banking Committee hearing, Senators Thom Tillis (R-NC) and Cynthia Lummis (R-WY) told Fed chair Jerome Powell they are concerned that regional banks “continue a pattern of stonewalling reasonable requests for information”.

Applicants for master accounts “are getting whipsawed between the Board of Governors and the banks”, Lummis said.

“The Federal Reserve says the banks have all the authority they need … to make these decisions and yet, you go to these reserve banks and they say, ‘Oh, now we’re waiting for the Board of Governors’.”

The senator stressed there is no end to this “whipsaw” and “black hole” of information and pressed Powell to address the matter.

The guidelines are now “an important step to provide transparency and consistency across the Federal Reserve System”, Fed governor Michelle Bowman said in a statement but she cautioned that it is “only the first step in providing a transparent process”.

Bowman emphasised that there is more work to be done before a process is established “to fully implement the guidelines”.

“There is a risk that this publication could set the expectation that reviews will now be completed on an accelerated timeline,” referring to the ongoing applications of Kraken and Custodia.

Earlier in June, Custodia sued the Fed over the “black-box” review process, seeking the court to order the FRB and the Kansas City Fed to “promptly” decide on its application that has been going on for more than 19 months.

Tiered framework

The guidelines lay out a tiered review framework to provide additional clarity on the level of due diligence and scrutiny that reserve banks will apply to different types of institutions with varying degrees of risk.

Institutions with federal deposit insurance would be subject to a more streamlined level of review, while institutions that engage in “novel” activities and for which authorities are still developing appropriate supervisory and regulatory frameworks would undergo a more extensive review.

The final guidelines are substantially similar to those proposed by the FRB in May 2021 and March 2022.

In response to public comments, the tiered review framework in the final guidelines was refined to provide more comparable treatment between non-federally insured institutions chartered under state and federal law.

The American Bankers Association (ABA) welcomed the guidelines but warned against doing “anything [that] undermine[s] the strength and resiliency of our banking system”.

“Allowing new financial players to access the Federal Reserve system without requiring them to meet the same high standards as banks poses real risks.”

The banks’ lobby group said it will “watch carefully to ensure that these new guidelines, particularly the tiering requirements, recognize those risks, and we look forward to seeing the Board and the Reserve Banks apply these guidelines fairly but rigorously".

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