Lawmakers join Custodia's legal battle with KC Fed over master account

Seven Republican lawmakers have joined the effort to compel the Federal Reserve Bank of Kansas City to give a a bank with a unique state charter access to its payment systems.

Three Senate Banking Committee members and four members of the House Financial Services Committee filed a brief with the U.S. District Court in Wyoming, arguing in favor of Custodia Bank's suit, which seeks to compel the Fed to make a decision about its application for a master account. 

The legislators argued that the Fed had exceeded its statutory one-year deadline to issue a decision on the application from Custodia, a Wyoming-based digital asset payment and custody provider. The brief also noted that the Fed was obligated to recognize the firm as a state-chartered depository institution and grant it a master account, or else it would exceed the limits of powers as defined by Congress.

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"As an essential feature of the dual banking system, Congress intended for states to be permitted to charter depository institutions under that state's laws, and as long as the institution comported with the definition of depository institution/bank under Federal law, Congress did not intend for the Board or Reserve Bank to substitute the prudent judgment of a state for its own," the lawmakers wrote. "This is a dangerous precedent."

The lawmakers who signed the brief, known as amicus curiae, were Sens. Cynthia Lummis, R-Wyo., Kevin Cramer, R-N.D., and Steve Daines, R-Mont., and Reps. Warren Davidson, R-Ohio, Ted Budd, R-N.C., Trey Hollingsworth, R-Ind., and William Timmons, R-S.C.

Along with giving Custodia's argument the imprimatur of Congress, the brief also highlights the legislative history of the Monetary Control Act of 1980, a law that granted the Fed greater regulatory control over non-member banks. That law requires the central bank to provide reserves to all banks, regardless of whether or not they are members. In doing so, the legislators argue, the law also expanded master account access to all banks willing to pay for the service.

The Monetary Control Act was "intended by Congress to apply to 'every depository institution in the country,' without exception," the legislators wrote. "This was meant to enable the Federal Reserve to have increased control over monetary policy by requiring all depository institutions to hold a specified amount of capital at their Reserve Bank based on their deposits."

The brief pushes back against the Fed's argument that it has the right to grant payment systems access to non-member banks, but not the obligation.

The filing comes roughly one month after the Fed motioned to have Custodia's lawsuit dismissed on the grounds that the company's business model was too new and untested, and therefore must be subject to additional scrutiny, as laid out by its newly established master accounts guidelines. The Fed is reluctant to expand access on its payment systems and risk establishing precedent for novel charters one way or another.

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On two previous occasions, the Fed has been able to block lawsuits about its master account policies. The first was for Fourth Corner Credit Union, a Colorado-chartered cannabis bank, and The Narrow Bank, a Connecticut-chartered institution that sought to hold all of its customers' deposits in risk-free reserves at the Fed.

For firms such as Custodia and Kraken, another Wyoming-based firm that has applied for a master account, the delay has become burdensome. Without access to the Fed's payment systems, the companies have largely been left idle. 

Lawmakers argue in their filing that the Fed Board and regional reserve banks are "arguing that they have the legal authority to determine what is a bank and what is not by abrogating a discretionary power to grant access to the payment system — one of the hallmark features of a depository institution."

Pressure from Lummis, whose home state passed a special charter specifically for crypto banks, and other members of Congress, have already forced the Fed to speed up its process for crafting policies related to fintechs and other novel charters. 

Lummis also made master account access a key provision of draft legislation on digital asset regulation she introduced with Sen. Kristen Gillibrand, D-N.Y., in June. That bill would codify the right of all state-chartered depository institutions to receive a master account. 

The state of Wyoming and two state legislators have also filed amicus briefs supporting Custodia's claims. 

The outpouring of support from elected officials and the state makes Custodia's case stand out relative to other groups that have sought to challenge the Fed over its master account policies, Julie Hill, a University of Alabama Law School professor whose research has focused on Fed master accounts, said. 

The effort also speaks to how much the state has on the line for its special purpose charter, she said.

"If Custodia's master account application languishes, it seems likely that many other SPDIs would face the same fate," Hill said. "Policymakers at all levels of Wyoming government seem to understand the implications of the Custodia suit for the SPDI charter. Their amici briefs show they want to help keep the SPDI charter alive."