Fed Account Guidance Yields More Confusion

In seeking answers from the Federal Reserve Board and one of the regional banks, a crypto fintech’s lawsuit may have forced the regulator to issue guidance on how other companies can gain access to the nation’s vaunted payment rails.

At issue are which companies are eligible to request master accounts at the 12 Federal Reserve Banks, and in turn, how the Reserve Banks should consider those requests. Central to this debate – and the timing of this guidance – is the Custodia lawsuit.

The day after the Board released the guidance, it asked a judge to dismiss a lawsuit from Custodia, a company that holds a special purpose depository institutions charter from the Wyoming Department of Banking. Custodia, which focuses on digital asset banking, custody and payment solutions, applied for a master account from the Federal Reserve Bank of Kansas City in October 2020, and sued both the Kansas City Fed and the Board this year to force a decision; the Board cited the final guidelines in its justifications for a dismissal.

“Honestly, it makes the guidelines seem like they were written, in part, to get courts to give [the Board] more deference when it winds up in litigation,” says Julie Hill, a law professor at the University of Alabama who has written about Fed account access.

Outside of the lawsuit, the guidance speaks to the interest that fintechs and companies with novel bank charters have shown in opening Fed accounts. A Fed account comes with access to the payment rails; the entire banking as a service (BaaS) business line is premised on banks serving as intermediaries and account holders for fintechs to send and store customer money.

If the path to applying for a master account becomes clearer, institutions with novel banking charters could bypass bank partnerships, and request and operate these accounts directly. But experts tell Bank Director that the Aug. 15 guidance codifies existing practices while offering little insight into how nonbanks can get these accounts – leaving most fintechs and bank partners where they started.

Companies that want Fed accounts request access from one of the 12 Reserve Banks, depending on which district the company is located in. The final guidance that the Federal Reserve Board issued is directed to those Reserve Banks; its involvement in these regional banks’ decision-making indicates that the Board is trying make these decisions consistent across regions and may be involved in individual requests as well, experts say.

The Fed’s guidance includes six principles that the regional Reserve Banks should use when evaluating these requests, along with a three-tiered review framework for the amount of due diligence and scrutiny that the Reserve Banks should apply to requests submitted by different types of institutions.

But observers still see shortcomings in the guidance. Several experts pointed out that the guidance doesn’t address which companies are eligible to apply, which is the first hurdle nonbanks must address before requesting an account. It was one of the most frequently asked questions that companies submitted to the regulator, says Matthew Bisanz, a partner in Mayer Brown’s financial services regulatory and enforcement practice.

The guidance retains the “substantial discretion” that Reserve Banks have in deciding approvals, meaning that institutions still do not have a clear path to account access, according to a Mayer Brown client note. The process is so unclear that these accounts are granted via requests rather than applications that regulators would normally employ, Hill points out.

Observers are waiting to see how the guidance figures into the Custodia case. Hill says that Custodia is an interesting test case; the company is in a strong position to request an account and addresses many of the regulator’s stated risk concerns. It has an ABA routing number and applied to become a member of the Kansas City Fed, which could advance it from tier three to tier two in the review framework. The company also accepts U.S. dollar deposits but does not have FDIC deposit insurance, which is one factor in the tier one considerations.

What’s Next
Hill says the next step for the Reserve Banks is potentially getting together to develop a sort of operating procedure, which could make the request and decision-making process more consistent across regions. And fintechs that might be interested in a novel bank charter may want to reach out to sympathetic lawmakers in Congress and explain their cause. Custodia and other crypto companies have found a champion in Sen. Cynthia Lummis, R-Wyo., and an ally in Sen. Pat Toomey, R-Pa., both of whom have raised concerns with the Fed and could author legislation that is more accommodative to novel banking charters that the Fed would need to follow.

In the meantime, companies that want a Fed account and aren’t interested in becoming bank holding companies or partnering with a BaaS bank may find themselves in limbo for a while. Bisanz points out that in litigation, the Fed cited a case that said delays of three to five years are not unreasonable; Custodia brought its lawsuit to expedite a decision. For novel banks, waiting years for a decision may as well mean the death of a business model.

“There is no guarantee of an application under these guidelines, and there is no guarantee of a decision,” Bisanz says. “Nothing in these guidelines says that the Reserve Banks will act expeditiously. People should read the guidelines, consider applying – but also be ready to sit tight.”