In the past month, the Federal Reserve, FDIC and OCC have each detailed their upcoming focus on digital asset activities in the banking industry. So far, state banking regulators have often outpaced their federal counterparts in terms of issuing formal regulations and guidance around digital assets. Many banks are waiting to explore potential digital asset products and services until the functional federal bank regulators provide concrete guidance to complete the picture.
FDIC Issues Request for Information on Digital Assets
On May 17, 2021, the FDIC issued a request for information (RFI) seeking input on the current and potential digital asset use cases involving insured depository institutions. The FDIC acknowledges the diverse applications being implemented and considered by banks, including using digital assets for settlement and payment systems, acting as digital asset custodians, performing node operations, and holding digital asset issuers’ money deposits.
As described in the RFI, the FDIC has found that potential digital asset use cases and related activities fall into one or more of five broad categories:
Technology Solutions—leveraging digital asset networks for certain technology solutions, including those involving closed and open payment systems, lending, or even acting as nodes in digital asset networks.
Asset-based Activities—asset-based activities include, for example, investments, collateral, margin lending and liquidity facilities.
Liability-based Activities—liability-based activities may involve bank deposits serving as digital asset reserves, which could involve custodying the dollars backing stablecoins.
Custodial Activities—custodial activities would apply traditional bank activities to digital asset activities, including general safekeeping of digital assets and related services, such as secondary lending, or acting as a qualified custodian on behalf of investment advisors.
Other—the final category is a catch-all for activities that do not fall into one of the above categories, which includes activities like market-making and decentralized financing (what is commonly referred to as “DeFi”).
Not surprisingly, the RFI has a heavy focus on risk management. The majority of questions where the FDIC is seeking comment involve understanding the risk and compliance management frameworks for the various digital asset use cases as well as the unique aspects that should be taken into account by the FDIC from a supervisory perspective.
Another expected focus of the FDIC is on insurance and resolution. The FDIC is seeking guidance on the specific complexities involved in valuing and resolving digital asset activities as well as actions that may overcome any such complexities.
It is important that the FDIC receives meaningful comments from the industry so that it can properly adjust its supervisory and examination framework. Banks are already effectively banking digital asset companies and developing new digital asset use cases, but they are essentially left with little guidance with respect to the FDIC’s regulatory expectations.
Interested parties should submit their comments to the FDIC by July 16, 2021.
Federal Reserve RFC on “Account Access Guidelines”
Another significant development involves the request for public comment (RFC) released by the Federal Reserve on certain proposed guidelines (the Account Access Guidelines) to assist the Federal Reserve with evaluating requests for accounts and services at the Federal Reserve Banks. The RFC is likely the result of several newly chartered digital asset-focused banks filing applications for master accounts.
The Federal Reserve highlights identifying bank risk management strategies as one of the primary goals of the Account Access Guidelines, which generally involves a focus on capital, risk frameworks, compliance with regulations and supervision. The Guidelines are centered on six broad principles, with the first principle clarifying that only legally eligible banks will be eligible for Federal Reserve account access and the remaining five principles ranging on specific risks from granting such access to the Federal Reserve system.
By implementing a principles-based approach to evaluating account access requests, the Federal Reserve believes that assessing applications from federally insured institutions “will be fairly straightforward in most cases.” It is the non-federally insured institutions potentially gaining access to the Federal Reserve system that is the suspected impetus behind the Account Access Guidelines and the RFC notes that such situations will likely require more extensive due diligence.
It appears that the account applications for the newly chartered “crypto banks” will remain pending until the Fed formally adopts the Account Access Guidelines. Comments on the Account Access Guidelines must be received on or before July 12, 2021.
Federal Reserve to Issue Discussion Paper on CBDCs
On May 20, 2021, the Federal Reserve also announced it plans to publish a discussion paper in the summer on the potential benefits and risks of issuing a US central bank digital currency. As part of the process, the Fed intends to ask for public comment on issues related to payments, financial inclusion, data privacy, and information security. “The paper represents the beginning of what will be a thoughtful and deliberative process,” Fed Chairman Jerome Powell said in a related video message. He continued, “we expect to play a leading role in developing international standards for CBDCs, engaging actively with central banks in other jurisdictions as well as regulators and supervisors here in the United States throughout that process.”
OCC Acting Comptroller Testimony
While the Federal Reserve and FDIC have taken a comparatively more cautious approach to issuing digital asset regulations and guidance, the OCC pushed ahead over the past year by releasing various significant digital asset-specific interpretive letters and issuing charters for non-traditional banks. Following the change in presidential administrations, the newly appointed Acting Comptroller of the Currency has signaled that this trend may have come to an end.
Testifying before the House Committee on Financial Services, Acting Comptroller of the Currency, Michael Hsu, compared the OCC’s approach towards digital asset activities to the “fragmented agency-by-agency approach” taken in the 1990s and 2000s. Hsu has asked his staff to review the actions taken by the OCC under his predecessor, which involves the various interpretive letters and chartering of certain national banks and trust companies that intend on providing digital asset-focused services. Additionally, Acting Comptroller Hsu noted his concerns around providing charters to fintechs, including granting benefits without corresponding responsibilities and encouraging growth of another shadow banking system outside of the purview of regulators.
Just the day before Hsu’s testimony, Senator Sherrod Brown (D-OH) sent a letter to him asking him to review the recently issued charters, specifically naming both such entities. While it remains to be seen how far the new Acting Comptroller will go in terms of undoing the work of his predecessor, it is clear that there will not be any new charters issued by the OCC for digital asset-focused fintechs for the time being. Going forward, any new charters issued by the OCC will have to be granted “in coordination with the FDIC, Federal Reserve, and the states.”
It is reassuring that Hsu specifically mentioned states in his testimony. As the federal regulators aim to coordinate on taking a consistent approach to establishing new digital asset regulations, we are hopeful they will consult closely with the many states that have taken the lead in establishing digital asset regulations. New York and Wyoming have each, for example, spent years working with industry stakeholders and digital asset experts to create robust digital asset regulatory frameworks.
Due to the dual banking system in the United States, the financial industry will not have full clarity on permissible banking activities in the digital asset space until both state and federal bank regulators have settled on established standards for evaluating digital asset activities. At this time, the federal bank regulators appear heavily focused on information gathering to inform future regulatory action, which means banks seeking more concrete guidance may have to remain patient for the foreseeable future.
Nevertheless, banks are also growing increasingly confident that they can offer many types of digital asset services by following sound risk management practices that are designed to mitigate the risks of digital asset activities. Such practices may have to be revisited after the forthcoming regulations and guidance is released, which will likely focus on ensuring the practices employed by banks are commensurate with the risks posed by the specific activities.