Fed seeks to buy time in legal battle with crypto bank Custodia

The Federal Reserve’s battle with crypto bank Custodia largely comes down to one thing: timing.

The Fed wants more time to work out its policies to grant fintech companies access to its payment systems. Custodia Bank claims to have already taken too long to process its request for a so-called main account.

In June, the Cheyenne, Wyoming-based digital asset custodial and payment provider filed a lawsuit against the Federal Reserve Bank of Kansas City to compel it to grant or deny its primary account application after waited almost two years.

The Federal Reserve is hoping to buy time to decide whether to grant a primary account to Wyoming-based crypto bank Custodia, but the bank is urging a federal court to force the central bank’s hand.

Bloomberg News

The Fed last week asked the U.S. District Court in Wyoming to dismiss Custodia’s lawsuit, a tactic it has already used twice to fend off litigation related to the main account – first from a bank of cannabis from the Colorado Fourth Corner Credit Union in 2017 and again in 2020 from The Narrow Bank in Connecticut, which sought to hold all customer deposits in risk-free reserves at the Fed.

If the strategy fails this time around and the Fed has to make a decision one way or the other, the consequences will reverberate far beyond Custodia, said Julie Hill, a law professor at the University of ‘Alabama whose research focuses on the main accounts of the Fed. The grounds on which it would grant or deny Custodia’s offer for a master account would set precedent for hosting other fintechs that have sprung up in the country under various state charter regimes, she said. .

“It might be in the back of the Fed’s mind that, ‘Listen, we have to be ready when this wave of applications comes, so if we’re going to grant the Custodia application, we shouldn’t grant it until we don’t. We won’t have all our ducks in a row,” Hill said.

Dennis Kelleher, president and CEO of the nonprofit organization Better Markets, warned the court against the Fed’s rush to decide whether crypto banks should have access to the Fed’s payments system and under what conditions. . He said these are critical questions that the Fed should answer in due course.

“These are complex and novel issues with serious implications for financial stability, and the law gives the Fed the responsibility and discretion to assess and balance the many competing and often conflicting public and private interests,” he said. Kelleher said. “Furthermore, if the court injects itself into such rulings – or worse, substitutes its judgment for that of the Fed – it will open the floodgates to endless lawsuits, dragging the courts deeper and deeper into crafting the policies where they have no expertise or experience.”

Even if the Fed succeeds in having the Custodia lawsuit thrown out, the mere filing of the lawsuit – combined with pressure from Sen. Cynthia Lummis, R-Wyo.and other members of Congress – has already forced him to act faster than he probably would have otherwise, said Kaleb Nygaard, a historian and economics researcher.

“Regardless of whether or not the lawsuit succeeds in obtaining a Custodia account, they almost certainly succeeded in accelerating the nationalization or equalization of policy throughout the Fed system,” he said.

Nygaard highlighted the Board of Governors new guidelines for granting master accountswhich were finalized a day before the motion to dismiss, as evidence that the Fed is accelerating its efforts to develop a policy for non-traditional primary account applicants.

The guidelines, which have been in the works for more than a year, create a three-tier system for applicants, federally insured and supervised institutions receiving the least scrutiny, and uninsured entities not supervised by banking regulators getting the most.

The impetus of the guidelines is to create a process for companies that hold so-called new charters that some states are granting to non-bank fintechs. This includes companies such as Custodia and Kraken, which are licensed as Wyoming special purpose depository institutions. Established by a 2019 statute, the classification allows companies to participate in certain banking activities.

Custodia and Kraken applied for main accounts with the Kansas City Fed, which oversees payment system access for banks in the Fed’s 10th district, in 2020 and are awaiting responses. Without access to the Fed’s payment rails, the two businesses have yet to get off the ground.

In laying out the guidelines, Fed Vice Chairman Lael Brainard said he had created a “consistent and transparent process” for evaluating primary account applications. Kelleher said the framework is a “proper deliberative process.”

Others view the guidelines less favorably. Norbert Michel, director of the Center for Monetary and Financial Alternatives at libertarian think tank Cato Institute, said the framework is light on details and gives the Fed broad cover to deny the application of fintech that would threaten banks. traditional. He said the guidelines primarily serve as a legal document he can refer to in the event of future litigation.

“They want something so that if they keep getting sued, they have, like, an APA-type fallback to say, ‘No, we have this process. We are putting this process in place. It’s systematic. We are thinking about this risk, this risk, this risk and this other risk,” Michel said, referring to the Administrative Procedure Act. “That’s all this document is.”

Hill said the risks considered by the guidelines are so broad that, in their current form, they provide little information about how best the new charters can position themselves to mitigate those risks. However, she said the guidelines will not be the end of the conversation within the Fed system about how to handle major accounts, but rather the basis for a more fleshed-out process as the 12 regional reserve banks gather around the issue.

“I expect the Federal Reserve to have updated processes that result from their collaboration among the Reserve Banks,” she said. “You can’t take non-law and turn it into law, but you can take advice and turn it into an application form to follow and a list of people to contact for specific types of banks.”