Fed Guidelines Look to Curb Fintechs Before They Run Wild

The banking industry's concerns over newcomers' access to Federal Reserve district banks and to the Fed payment network spurs the central bank to issue a potential framework to impose bank-like risk controls and more on them.

The small but growing population of banks with specialized charters, coming against the backdrop of the increasing banking ambitions of fintechs and big techs, has led the Federal Reserve to propose uniform guidelines for requests to establish accounts and obtain services at the 12 district banks of the Federal Reserve System.

The move comes in the wake of an increase in what the Fed calls “novel charter types” being authorized or considered around the country. Among these are limited-service national bank charters, the payments bank charters suggested by former Acting Comptroller Brian Brooks, and special state charters such as Wyoming’s crypto banks. The proposal does not cover state-chartered industrial loan banks nor the fintech charter of the Comptroller’s Office. (None of the latter have been granted as it remains under legal challenge.)

While permission to open Fed system accounts rests with each district bank, “the proposed guidelines would reduce the potential for forum shopping across Reserve Banks and mitigate the risk that individual decisions by Reserve Banks could create de facto System policy for a particular business model or risk profile,” the central bank stated in a preamble to the proposal.

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Worries About Risk Mix with Traditional Players’ Competitive Concerns

Federal Reserve Board Governor Lael Brainard, in a statement issued with the proposal, said that the guidelines would allow consistent evaluation of requests from the novel institutions while promoting “a safe, efficient, inclusive, and innovative payment system, consumer protection, and the safety and soundness of the banking system.”

If You Want to Join the Club…

The Fed document goes into substantial detail regarding six principles it would set for considering requests from the new “novel bank” players for access to having Fed bank accounts and services.

Expectations would include having effective risk management and compliance programs in place. The fourth principle states that “provision of an account or services to an institution should not create undue risk to the stability of the U.S. financial system.” The fifth principle addresses avoidance of risks of money laundering, terrorism financing, fraud, cybercrimes and other illicit activities.

A Fed staff memo noted that “some industry stakeholders have raised questions about the potential risks if entities holding non-traditional charters obtain Federal Reserve accounts and services.”

An example was a comment letter filed by eight financial services trade associations — including groups representing large banks, small banks, credit unions and more— regarding the application of Kraken Financial for access to Fed services.

Kraken Financial, a cryptocurrency exchange, formed an uninsured bank — Kraken Bank — under Wyoming law. Among its purposes is to provide a connection between digital assets and national currencies. This “special purpose depository institution” applied to the Saint Louis Fed District Bank and drew the trade groups’ fire.

Only the End of the Beginning:

In an October 2020 joint letter, the associations requested a delay for granting such requests from novel institutions until a uniform system policy could be adopted. The May 5 action is the first step.

In a blog on the St. Louis Fed Bank’s site, it notes that “it is not always clear whether institutions granted a special-purpose or other type of novel charter are eligible for federal deposit insurance, access to the payments system, or access to the discount window.”

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A Shot Over the Bow for Fintechs and Big Tech?

The Federal Reserve’s release of the proposed guidelines was greeted in a statement by Greg Baer, President and CEO of the Bank Policy Institute.

“The issue of who can access the Federal Reserve’s payment system is an important one, and it is good that the Fed has sought comment on the complex questions surrounding it,” said Baer.

“Historically, only regulated and supervised banks have been permitted access, and if Big Tech and fintech firms seek that right, the question is whether they ought to shoulder the traditionally associated responsibilities and whether further protections are warranted given that they are uninsured and lightly regulated, and therefore inherently riskier to the system.”

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