Fed announces new guidelines after master account controversy

Rules will impose tight scrutiny on non-conventional applicants
federal reserve

The Federal Reserve board finalised a new set of guidelines for granting banking services to financial institutions on August 15.

The new US rules set up a tiered system of review which will shape how Federal Reserve banks evaluate requests for central bank accounts and other services.

Federal Reserve vice-chair Lael Brainard said that the regulations will “provide a consistent and transparent process to evaluate requests for Federal Reserve accounts and access to payment services”.

These accounts, called master accounts, permit financial institutions to access the US wholesale payments system. Non-banks without such access must set up arrangements with an established bank, which fintech and crypto advocates say is an unfair restraint against new businesses.

Several non-bank financial institutions, including virtual asset service providers, have attempted to obtain master accounts. One cryptocurrency service provider, Custodia Bank, sued the Federal Reserve board and the  Kansas City Fed in June, demanding they act on a long-delayed master account application.

In a separate statement, Fed board member Michelle Bowman said: “The publication of the non-traditional account access guidelines is an important step to provide transparency and consistency across the Federal Reserve system with respect to such requests”.

However, Bowman warned that financial institutions should not expect applications to be considered “on an accelerated timeline”.

The Fed board sets general rules for the Federal Reserve system as a whole, including the broad conditions for granting master accounts. The Federal Reserve banks – the 12 regional reserve banks – grant, administer and withdraw master accounts at their discretion. In the new guidelines, the Fed board reaffirms “that legal eligibility does not bestow a right to obtain an account and services”.

Typically, only “depository institutions” may hold master accounts, a term that usually means banks or similar institutions like savings associations.

The Fed first invited comment on its proposed guidelines in May 2021. A second notice put forward the tiered review framework in March 2022. The Fed board said that responses split between “those which supported and those which opposed greater account access for institutions with novel charters”.

Tiers for fears

The new guidelines introduce a “tiered review framework”, with three levels, which will determine how intensively regional reserve banks review master account applications.

Tier 1 will apply to “eligible institutions that are federally insured”, meaning they are covered by the Federal Deposit Insurance Corporation, which also supervises banks. Because these are already subject to oversight, and because regulators have a great deal of information about these institutions, “access requests by Tier 1 institutions will generally be subject to a less intensive and more streamlined review”.

Tier 2 oversight will apply to “eligible institutions that are not federally insured but are subject (by statute) to prudential supervision by a federal banking agency”. This category would include state-chartered banks that are members of the Federal Reserve system, banks under Fed-regulated bank holding companies and branches of foreign banks. This category will undergo “an intermediate level of review”.

Tier 3 will encompass “eligible institutions that are not federally insured and are not considered in Tier 2”. This classification would presumably include cryptocurrency asset custodians and fintechs. “Tier 3 institutions will generally receive the strictest level of review,” the guidelines state.

Lee Reiners, a law professor at Duke University, tells Central Banking that the Fed is likely trying to standardise its approach to digital finance sectors. “The Fed board recognised recent master account applications presented novel policy issues and they didn’t want to leave it to the district banks to make decisions that could impact the broader payment and banking system,” Reiners says.

Reiners agreed that most cryptocurrency and fintech firms would fall into the Fed’s Tier 3. “This doesn’t mean it’s impossible for these firms to get a master account, but it will be much much harder for them as compared to a traditional bank,” he says.

Julie Hill, a professor at the University of Alabama school of law, notes that some “novel banks” were not involved in crypto. She cited the example of a publicly owned bank in the US territory of American Samoa, which lacked deposit insurance. It waited two years for the Federal Reserve Bank of San Francisco to approve its master account application, she said.

Hill added that “the Federal Reserve is very secretive about how it handles [master account] applications”, so it is hard to say how the new guidelines will change its practices. “Even prior to the guidelines, Federal Reserve banks scrutinised the risk posed by novel bank applicants” and “there is little evidence that the reserve banks were previously ignoring any of the risks with respect to novel bank applications”, she said.

The new rules will come into force once published in the Federal Register, the official compilation of US regulations.

Suing for service

One fintech non-bank trust company, Colorado-based Reserve Trust, received an account with the Kansas City Fed in 2018. The Fed bank has since closed this account.

The Reserve Trust account has become the core of an ongoing political dispute that has pitted the Republican party Senate members against both the Fed and the White House. The controversy foiled US president Joe Biden’s attempts to name Sarah Bloom Raskin, a former Fed governor, as Fed vice-chair for supervision.

Senate Republicans accused Raskin of improperly lobbying the Kansas City Fed to grant the master account when she served on Reserve Trust’s board. The resulting criticism was one element compelling Raskin to withdraw her candidacy for the position in March 2022.

Since then, Senate Republicans on the banking committee have demanded records relating to Reserve Trust from the Kansas City Fed. In a June 16 letter to senator Pat Toomey, the ranking Republican on the banking committee, Kansas City Fed president Esther George said she would not disclose “highly sensitive confidential supervisory information”.

Senate Republicans sent Fed chair Jerome Powell another letter on August 9 lamenting the central bank’s refusal to share Reserve Trust records with the committee.

The US state of Wyoming has established a legal category of “special-purpose depository institutions”, or SPDIs, mainly to allow cryptocurrency custody services to operate in the state. Two of these SPDIs, Kraken Bank and Custodia Bank, have applied for master accounts with the Kansas City Fed.

Custodia sued the Kansas City Fed and the Fed board in June. The Wyoming firm claimed that the authorities had delayed its application for an unlawfully long time and demanding that a US federal court order the Fed to make some decision on it.

Reiners thought the Fed’s stance towards the Wyoming SPDIs would not change under the new regulatory structure. “I think the new guidelines leave the Federal Reserve with enough optionality to reject master account applications from entities with ‘novel charters’, such as Wyoming SPDIs, and that’s what I expect they will end up doing,” he said.

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