The landscape around accessing the federal payments system has changed. The question is whether the Federal Reserve has instigated this shift or merely responded to it.
According to a trio of recent federal court decisions — two of which were
Some policy and legal experts say the net sum of these decisions amount to a coup for the Fed, giving it carte blanche to decide what firms are qualified to engage in banking.
"There's no limit to the Fed's asserted discretion over the global payment system," said Peter Conti-Brown, a Fed historian and professor of legal studies at the University of Pennsylvania's Wharton School of Business. "This is a major problem."
Other scholars and some payments specialists say the rulings merely recognize the authorities the central bank and its regional reserve banks have always had.
Jess Cheng, a partner at the law firm Wilson Sonisi and a former attorney for the Federal Reserve Board and Federal Reserve Bank of New York, said the only new development around the administration of so-called master accounts — which grant banks access to the Fed's financial services — is the volume of requests from non-standard applicants.
"What has changed is the attention around master accounts because of the types of entities that are now interested in and intending to access the nation's payment rails," Cheng said. "That's what's changed."
The two most recent court rulings on master accounts are the U.S. District Court in Wyoming's decision in Custodia v. the Federal Reserve Bank of Kansas City and the Federal Reserve Board, and the U.S. District Court in Idaho's dismissal of a suit brought by PayServices Bank against the Federal Reserve Bank of San Francisco.
In both cases, the two neobanks were suing their regional reserve banks over master account denials. The decisions were issued within one day of each other, with the ruling against Custodia being cited as a reason for dismissing the PayServices suit.
While different in many ways, the two claims argued that, as state-chartered banks, Custodia and PayServices were both entitled to master accounts. This stance is based on a provision of the Monetary Control Act of 1980, which granted access to the Fed's financial services to depository institutions that were not members of the Federal Reserve System.
The debate centers on whether the law's assertion that the Fed "shall" make master accounts available to nonmember banks meant the central bank must do so or if it had the option to do so.
Judge Scott Skavdahl, the Wyoming judge overseeing the Custodia case, wrote in his decision that for the argument to be true, Congress would have been violating a long-held statutory construction principle that it not "hide elephants in mouseholes" — a legal interpretation that lawmakers cannot hide sweeping changes to regulatory frameworks in "vague terms or ancillary provisions." Therefore, he wrote, the act in question stands as proof that Congress wanted the Fed to have discretion over which banks can have master accounts.
But Conti-Brown — who was retained by Custodia as an expert witness for the case and provided written testimony — said Skavdahl's reading of the law would amount to using a vague statute to grant the Fed a significant authority.
"The idea that Congress gave the Fed untrammeled authority to deny all of these depository institutions access to the payment system based on its own whims is exactly the thing that the MCA was trying to stop," Conti-Brown said. "The argument that Congress tried to do one thing and did the complete opposite does not give me much confidence in this district court judge."
Yet, Skavdahl is not alone in his assessment of the law. David Zaring, another legal studies professor at Wharton, said the court's view is correct.
Zaring, who submitted an amicus brief to the Custodia case arguing in favor of the Fed, said it is appropriate for the central bank to have some say over what entities can access its payments networks.
"I don't think it makes sense to set up a regime where the Fed has no discretion over whether a bank has access to its payment rails without being able to inquire about its solvency or risk management practices," he said. "I could also foresee a situation in which states start playing politics with their charters and issue special purpose licenses to oil companies or labor unions, thus dragging the Fed into politicized debates that it should not be involved in."
Zaring also argues that the Fed is not completely unfettered in its decision making, noting that it is subject to the Administrative Procedures Act, which denotes that its application decisions are subject to legal review.
Meg Tahyar, a regulatory lawyer with the law firm Davis Polk, believes the ultimate decisions reached in the three master account cases will come down to statutory interpretation. But, she said, such a debate is not the ideal forum for addressing the key question of what entities should be able to engage in payments in the 21st century.
"I make a clean break in my mind between the policy question of whether non-traditional banks, fintechs or payment companies should get master accounts — is that a good policy idea — and what the statute actually says," Tahyar said. "We're having this legalistic fight when what we should really be asking ourselves is: Who should have access to a master account?"
An ironclad view on payments system access and the Fed control over it would take an act of Congress, the likes of which is not being discussed broadly — if at all — on Capitol Hill.
Recent years have seen the Fed establish a framework for assessing master account applicants. The three-tied system applies the most scrutiny to banks chartered at the state or territory level that have no federal regulator, while giving the least scrutiny to federally supervised member banks.
Cheng, who helped craft the guidelines during her time with the Fed Board of Governors, said the framework largely mirrors the one employed by the New York Fed during her tenure there.
"The New York Fed had its own playbook that was very well developed because we got so many requests and it took a more sophisticated analysis," she said. "The board basically formalized it and applied it across the system."
Cheng noted that regional reserve banks still have the ability to conduct their own risk assessments and use the system-wide framework as they see fit. She added that the Fed is right to be vigilant in keeping out entities that aren't up to snuff.
"The payment system links everyone together; you have risk exposure to everyone else in the system," Cheng said. "And it's not just the safety of the system, but also the efficiency. You want certainty, clarity, you want to know that you're dealing with competent counterparties. If there is a deficiency or there's doubt about an entity, that's exposure to everyone in the payment system."
Neither Custodia nor PayServices has said whether they will appeal the decisions in their cases, but legal experts tracking the events expect them to do so.
A third bank, Puerto Rico-based Banco San Juan Internacional is
Despite the string of victories by the Fed, Julie Hill, a law professor at the University of Alabama who researches master account policy, said technically it is too soon to say that the Fed's broad authority over master accounts is settled law — but it could be soon.
"At some point, when you have no split of opinion among the circuits, it might as well be settled, but that's not where we're at yet," Hill said. "We still haven't seen any courts of appeals clearly decide this issue, so we still have some legal ambiguity."
For Custodia and PayServices, a successful appeal hinges on finding a panel of judges to interpret the Monetary Control Act as they do, Hill and others said, which is possible, given the polarizing nature of the passage in question.
Still, Hill said she expects the decisions to have a "chilling effect" on other nontraditional banks that might have otherwise sought access to the payments system.
In the meantime, the Fed's challengers will have to continue mounting a legal battle while also attempting to engage in banking without access to the nation's payments system.
"The Fed's been playing the delay game, and so far they've done it really effectively," Tahyar said. "So far, they're winning."
