Custodia Bank's bid to get access to the Federal Reserve's payment system was dealt a blow Friday morning.
The Federal Reserve Board of Governors denied the Cheyenne, Wyoming-based digital-asset bank's application to be a state member bank on the grounds that its "untested" business model is too risky.
Custodia had sought membership in the Fed — a status that would have made the Board its primary supervisor — alongside its two-year-old effort to obtain a so-called master account with the Federal Reserve Bank of Kansas City.
Custodia's account application is the subject of a
In its decision Friday, the board cited concerns about Custodia's business model, which centers on providing custody services for cryptocurrencies and other digital assets, and aspires to include issuing its own stablecoin. The board questioned the firm's ability to manage risks related to money laundering and illicit finance.
"The firm's novel business model and proposed focus on crypto-assets presented significant safety and soundness risks," the Fed's statement reads. "The Board has previously made clear that such crypto activities are highly likely to be inconsistent with safe and sound banking practices. The Board also found that Custodia's risk management framework was insufficient to address concerns regarding the heightened risks associated with its proposed crypto activities, including its ability to mitigate money laundering and terrorism financing risks."
Custodia CEO Caitlin Long said in a written statement that she was "surprised and disappointed" by the decision, adding that her company was given a 72-hour notice that it could "either withdraw its membership application or see it denied."
By blocking Custodia from being federally regulated, Long said, the Fed was passing up an opportunity to bring digital asset servicing into the regulatory perimeter and, in doing so, resolving to keep much of the sector's activities in the shadows.
"Custodia offered a safe, federally regulated, solvent alternative to the reckless speculators and grifters of crypto that penetrated the U.S. banking system, with disastrous results for some banks," Long said. "Custodia actively sought federal regulation, going above and beyond all requirements that apply to traditional banks. The Board's denial is unfortunate but consistent with the concerns that Custodia has raised about the Federal Reserve's handling of its applications, an issue we will continue to litigate."
The Board of Governors declined to comment on how the decision might impact the ongoing litigation.
The board's assessment of Custodia's risk management practices could prove damning, but it does not end the bank's push to get a master account. Fed policy states that such decisions
Still, the board's decision blocks Custodia from getting an easier pass from the Kansas City Fed. Under the Fed's
Julie Hill, a law professor at the University of Alabama whose research on financial regulation focuses on master accounts, said the board's safety and soundness concerns make it unlikely that the Kansas City Fed will grant Custodia a master account.
Should the Kansas City Fed deny Custodia's master account application, that action could, conceivably, negate the bank's lawsuit, which seeks to compel the reserve bank to make a decision. But, if that is the case, Hill said, that is unlikely to be the final word on the matter.
"Even if the court were to say, 'Well, this case is been decided because they decided on the master account,' I would expect Custodia to just immediately re-file a complaint about the denial," she said. "That wouldn't be new or surprising given the arguments that the parties have been making all along in that lawsuit."
Crypto skeptics lauded the Fed's decision to deny Custodia membership as further evidence of regulator's resolve to keep digital assets out of the U.S. financial system.
Dennis Kelleher, head of the consumer advocacy group Better Markets, credited regulator's efforts to keep crypto at an arm's distance from the banking sector with preventing the market's volatility from impacting the broader economy. He called Friday's denial a "win for financial stability and taxpayers."
"The crypto industry and its many allies will object to today's decision and no doubt sue, but no one should forget that the Fed's actions today are in the best interests of the banking system, the country, and Main Street taxpayers," Kelleher said in a written statement.
Alongside its ruling on Custodia's membership application, the Fed board also issued a policy statement aimed at standardizing the scrutiny applied to federally supervised banks looking to engage with crypto or other novel business practices, regardless of whether or not they had federal deposit insurance.
The policy is aimed at creating equal standards for state member banks regulated by the Fed and federally insured national banks supervised by the Office of the Comptroller of the Currency. It specifies that all firms should have adequate risk management processes, internal controls and information systems for the activities they are involved in.
"The statement also makes clear that uninsured and insured banks supervised by the Board would be subject to the limitations on certain activities imposed on national banks, which are overseen by the Office of the Comptroller of the Currency," the board noted in a press release. "The equal treatment will promote a level playing field and limit regulatory arbitrage."
The statement notes that banks are not banned from providing custody services for crypto assets, but notes that institutions that engage in that activity must be in compliance with best practices for safety and soundness, as well as all applicable laws related to money laundering, the funding of terrorism and consumer protection.
While the Fed and other bank regulators have not crafted specific regulations around bank engagement with crypto assets and companies, such activities have been the subject of intense supervisory oversight. Earlier this month, the Fed, OCC and Federal Deposit Insurance Corp. issued a joint statement telling banks to
Hill sees the Fed's latest policy statement, the denial of Custodia's membership application and various other actions by federal regulators from the past year as painting a clear picture for banks looking to engage with the crypto sector that doing so will not be viewed favorably.
"Taking the Custodia decision today, combined with the White House's statement on crypto, combined with the Fed's statement on them treating all novel banks and other banks the same with respect to crypto and setting a rather high bar for participating in it, I think that the overall message has to be that this administration, at this point, is quite skeptical of crypto," she said.
