The Situation: The Federal Reserve Board ("Board") has issued a new policy statement ("Policy Statement") imposing limits, including Board approval requirements, on digital asset activities and other novel activities of state-chartered member banks.
The Result: The Policy Statement generally defers to the Office of the Comptroller of the Currency ("OCC"), applying substantive requirements and, in some cases, processes, such as "supervisory nonobjection," of the OCC to applications by state banks that are members of the Federal Reserve System ("Fed"). The Policy Statement applies broadly, but its preamble suggests that the Board's initial focus is on digital asset activities.
Looking Ahead: Although the immediate impact of the Policy Statement will likely be on digital asset activities, the terms of the Policy Statement apply to "novel and unprecedented activities" generally. And while the Policy Statement appears at first blush to reflect Board deference to the OCC (and FDIC as appropriate), its effects are more likely to constitute a check on the ability of state banking authorities to permit state banks to develop innovative methods and new technologies to conduct the business of banking.
At its best, the dual banking system in the United States allows the states to act as Justice Brandeis's "laboratories of democracy." Frequently during the banking industry's history, innovation has taken place at the state level. And what is innovative today may well become standard or even banal tomorrow: For example, it was state banks that first introduced the checking account to U.S. consumers.
The publication of the Policy Statement appears to have been driven by the Board's concerns regarding the risks of cryptocurrency to the stability of the banking system (or perhaps even to the stability of individual banks with significant exposure to cryptocurrencies), and it may well succeed in reducing those risks. But its effects will also include limiting the flexibility of state banking authorities and the banks they charter (at least those that are Fed member banks) to innovate over time, using methods and technologies that have nothing to do with cryptocurrency.
On its face, the Policy Statement announces that, under Section 9(13) of the Federal Reserve Act, the Board is adopting a rebuttable presumption that state member banks may engage as principal only in activities permissible for national banks unless explicitly authorized to do so by federal statute or FDIC regulation—and may only do so subject to any attendant conditions imposed by the applicable federal regulator. Otherwise, the Board will treat requests to engage in such a "novel and unprecedented" activity as a change in the general character of the business of the bank such that the state member bank must obtain Board permission under Regulation H, under a rebuttable presumption that the activity is impermissible.
In the preamble, the Board provided two examples of how the rebuttable presumption process would impact digital assets: (i) under the Policy Statement's framework, there is no legal basis for holding digital assets as principal; and (ii) state member banks may not issue "dollar tokens" (a new term roughly analogous but not identical to stablecoins) except as permitted by existing OCC interpretive letters. Therefore, a state member bank would have to obtain "supervisory nonobjection" from Fed staff before issuing a stablecoin: a hurdle unlikely to be surmounted under the Policy Statement and other recent guidance.
The Board published the Policy Statement on the same day that the Fed denied Custodia Bank's application for membership and a master account. Custodia, a Wyoming special purpose depository institution ("SPDI"), had applied for Fed membership nearly two years ago. Custodia sued the Board and the Federal Reserve Bank of Kansas City, its regional Federal Reserve Bank, in an attempt to force the Fed to act on its application. In denying the application, and consistent with the Policy Statement, the Fed cited safety and soundness risks associated with Custodia's proposed digital asset activities. It also reasoned that Custodia did not have a sufficient risk management framework to mitigate such "safety and soundness risks" that generally accompany digital asset activities.
Although some stakeholders may welcome the Policy Statement's transparency, it is a notably broad assertion of federal authority over creations of state law and a potentially high cost to pay for the privilege of Fed membership. In taking significant steps to reduce risks that appear largely to be limited to a handful of financial institutions, the Policy Statement raises a host of questions ranging from the merely technical to the overarching dynamics of the dual banking system:
- Will the Board expect state member banks to comply with nonpublic terms, conditions, and limitations imposed on national banks?
- Will the Board distinguish between: (i) nonbinding terms, conditions, and limitations set forth in guidance documents such as interpretive letters; and (ii) enforceable conditions "imposed in writing" within the meaning of 12 USC 1818?
- What role will regional Federal Reserve Banks and state banking authorities play in the Board's process under the Policy Statement, including in rebutting the Board's presumption?
- Will the FDIC respond in kind, to harmonize powers between state member banks and state non-member banks?
Two Key Takeaways
- The Policy Statement gives the Board greater leverage over state member banks seeking to engage in any "novel and unprecedented activities."
- State member banks should expect significant scrutiny when attempting to proceed with "novel and unprecedented activities," including digital asset activities, and should expect to face heightened skepticism from the Fed generally, and more involvement from the Board specifically.
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