A long-running debate about which institutions can access the Federal Reserve’s services is nearing a tipping point.
The question has been swirling around regulatory circles for years. Traditional banks, most of which are federally insured and supervised, have been at odds with fintechs and other newcomers, especially those dealing with legal cannabis or cryptocurrencies that are chartered only at the state level.
That question appears to have come to a head through several unrelated developments in a single week. Two senators introduced a bill that
This confluence of events has increased the likelihood that limits may be placed on the Fed’s unilateral discretion in whether it will or will not grant applicants a master account, and some fear that such an evolution could open the Fed’s payment system to a litany of underregulated actors.
“There's just not a good legal argument for why you should automatically get an account just because you think you're legally eligible,” said John Court, general counsel and head of regulatory affairs for the Bank Policy Institute.
Meanwhile, banks with so-called novel charters are fretting over the fact that one of their own could have their access revoked without a clear explanation.
“It’s very disturbing that they could do something like that,” the CEO of a small bank that requested anonymity to discuss the Fed’s master account process, said. “I don’t know why that would have happened.”
Others see the heightened attention being paid to master account policies as hastening the resolution of some related, long-running issues about how the Fed operates.
Aaron Klein, a senior fellow in economic studies at the Brookings Institution, said the Fed was never given the authority to decide which banks are given access to its services, but rather it has “invented” that discretion. He hopes recent events will make it clear that some reserve banks have overstepped their mandates.
“This spotlight is long overdue,” Klein said. “Certain regional Feds have used their master account authority to engineer social policy.”
The first blow to the master account status quo landed on Tuesday as part of a sweeping digital asset regulation bill introduced by Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y. One provision of the draft legislation states that any bank with a state charter is entitled to a master account with the Fed.
Like Klein, the senators argue the Fed and its reserve banks have no statutory right to determine which chartered banks should be eligible for master accounts. Yet, dating back to at least 2014, some reserve banks have been reluctant to grant access to institutions with business lines that are not federally regulated.
Traditional banks and their backers say this type of discretion is key for protecting financial stability, and the Fed maintains it has the right to apply additional requirements to banks that participate in riskier activities. Should the Lummis-Gillibrand bill pass, analysts and industry participants say the Fed would no longer be able to use that standard to reject an application outright.
“That’s my reading of it,” said Julie Hill, a law professor at the University of Alabama. “You get an account if you have a state charter, under the Lummis-Gillibrand bill.”
Also on Tuesday, Custodia Bank, a bitcoin depository based in Wyoming, filed a lawsuit against the Federal Reserve Bank of Kansas City, making it at least the third group to sue a reserve bank over a master account application in the past decade. In its suit, Custodia urges the Kansas City Fed to make a decision on its account application, which was filed in October 2020.
Critics say the Fed has a track record of dragging its feet on applications from novel charters. The Lummis-Gillibrand bill would also require reserve banks to process such requests within one year and provide a list to Congress of applications that are at least nine months old.
While the suit would be difficult to win, given the opacity of the approval process and the Fed’s abundant legal resources, Hill said, it could encourage the Fed to move more quickly on Custodia’s application to avoid a protracted battle.
“It might be a way to tell the Federal Reserve, ‘Look, we're really fed up with this and we'd like a decision, please do it,’ ” Hill said. “It might also raise the issue of public consciousness.
“Two weeks ago, no one was calling me about this,” she added.
Finally, on Thursday, reports surfaced that Reserve Trust Co., a Colorado-chartered non-depository trust company that became the first financial technology firm to be granted a master account in 2018, may have had its account revoked by the Kansas City Fed. Toomey, the ranking member on the Senate Banking Committee, raised the issue in a letter to the Kansas City Fed President Esther George, which was subsequently released to the press.
American Banker could not verify that Reserve Trust no longer has a master account. The company did not respond to requests for comment and the Kansas City Fed declined to discuss the matter. There is no public register of banks with master accounts at any of the reserve banks.
Reserve Trust, which once featured its master account prominently in its market materials, has scrubbed any mention of it from its website.
The company’s access to the Fed’s payment system was
A former Fed governor and deputy Treasury secretary, Raskin took a position on Reserve Trust’s board after leaving public office. The company’s initial application for a master account in 2017 was denied, but after Raskin joined it was ultimately successful in acquiring a master account.
During the February hearing, Republicans on the committee pressed Raskin about what role she played in the company’s acquisition of a master account, asking if she used her experience within the Federal Reserve System to influence the outcome. She said she did not recall. Insisting she provide more information, Republicans refused to advance any of Biden's Fed nominees. Raskin ultimately
Whether or not the controversy caused the Kansas City Fed to revoke Reserve Trust’s master account, Fed watchers see the episode as a testament to the central bank’s need for a unified policy on master account approval.
Last year, the Fed Board of Governors rolled out a three-tiered structure for evaluating banks seeking master accounts. The top, least-scrutinized tier would consist of federally insured and subject to prudential oversight, the middle would be uninsured entities subject to prudential oversight and the lowest tier would be groups that are neither insured nor supervised.
The Fed has not yet finalized its system for master account access, and its
"In the aftermath of the 2008 financial crisis, the Federal Reserve Board has asserted its authority over the Reserve Banks when it comes to bank supervision and examination matters,” Court said. “They are now also realizing that the reserve banks probably have not enough oversight when it comes to the granting of these [master] accounts. ... They've recognized that problem and they have developed proposed guidelines that they've issued for public comment twice. We think those proposed guidelines do an excellent job identifying all of the factors reserve banks should consider in applications from entities that are seeking master accounts."
Klein said the Fed board’s efforts to optimize its process does not change the fact that it is operating outside the letter of the law.
“The core question here is not, what are the metrics of discretion the Fed should apply?” he said. “The core question is, does the Fed have any discretion in granting these accounts to banks that have been chartered by other entities? The Fed insists it has discretion. Many people read the law and say that it does not.”
Because of this dispute over where the Fed’s jurisdiction ends, Lou Crandall, the chief economist at Wrightson ICAP, said the ultimate answer for who gets a master account and who might have to come from Congress. And he does not expect the Fed to get in the way of that.
“This has become a critical ingredient in what have become a couple very high-profile debates. On the one hand, the fintech innovation debate, and then its mirror image, the stablecoin financial stability debate,” Crandall said. “You have different constituencies pushing very hard for action on both of those. They're interrelated, but the Fed is not going to front-run the political community, which ultimately has to decide on the policy goals here.”
