WASHINGTON — The Federal Reserve sent a supervisory letter Tuesday to banks it oversees that outlines the process they must follow before issuing or redeeming stablecoins or holding them in custody.
"A state member bank seeking to engage in [stablecoin activities] is required to demonstrate, to the satisfaction of Federal Reserve supervisors, that the bank has controls in place to conduct the activity in a safe and sound manner," the letter said. "A state member bank should receive a written notification of supervisory non-objection from the Federal Reserve before engaging in the proposed activities."
The agency said banks must demonstrate they understand the various legal and reputational risks, possess adequate capital and liquidity buffers, as well as have in place strong risk management practices, compliance controls and contingency plans before they may be given the green light.
In addition to establishing the new non-objection process for state member banks, the Fed created a program to supervise novel activities like stablecoins at the banks it oversees.
"The program will help ensure that regulation and supervision allow for innovations that improve access to and the delivery of financial services, while also safeguarding bank customers, banking organizations and financial stability,"
The Fed said rather than moving banks with novel activities into a separate portfolio, the program will be integrated into the central bank's existing supervisory processes and that it will assign program experts to work with supervisory teams.
For purposes of the new program, the Fed is defining novel activities as those in which a nonbank serves as a provider of banking products and services directly to customers through online automated banking applications as well as those related to cryptocurrency, distributed-ledger or blockchain technology or those with concentrated activities with crypto banks or other fintechs.
"The program will be risk-based, and the level and intensity of supervision will vary based on the level of engagement in novel activities by each supervised banking organization," according to the release.
The Fed said it also plans to notify banks that will be subject to the examination in writing, periodically reevaluate the list of banking organizations subject to the examination and keep applicable banks notified of any changes in status. In addition, the Fed says it will monitor supervised banking organizations that are exploring novel activities, even if the bank has not yet engaged in any.
The Fed made the announcements a day after PayPal launched its own U.S. dollar-backed stablecoin, PYUSD, which will be issued by Paxos Trust Co., a licensed limited purpose trust company overseen by the New York State Department of Financial Services.
PayPal's launch of PYUSD is the most significant move by a mainstream U.S. financial institution of its size into the stablecoin arena, which has been dominated by crypto companies such as Tether and Circle. The Fed's announcements on Tuesday indicate it wants to step up its supervision over novel technologies such as cryptocurrency and stablecoins which have a growing influence over the financial system.
