On June 10, 2021, the Texas Department of Banking issued an industry notice addressing the authority of Texas state-chartered banks to provide virtual currency services to customers. This is a notable development as Texas has the most state-chartered banks of any state in the country.
Similar to the conclusions made by the OCC in its virtual currency interpretive letters, the Texas Department of Banking explains that the safekeeping of virtual currency is merely a modern form of traditional custody services. While acknowledging that there are certain differences between the safekeeping of physical and virtual assets, the notice highlights that the authority to provide virtual currency custody services already exists under Texas Finance Code § 32.001.
The notice underscores the Texas Department of Banking’s position that new regulations may not be necessary to address virtual currency activities of banks. Banks are already subject to a robust regulatory framework that captures the primary risks involved in offering virtual currency services.
Even though the significance of the notice should not be minimized, it does not mean that every Texas state chartered bank can immediately begin offering virtual currency services. The notice emphasizes that “it is incumbent on management to conduct due diligence and carefully examine the risks involved in offering a new product or service through a methodical risk assessment process.”
The types of custody services that a bank may provide will depend on whether the services are provided in a fiduciary or a non-fiduciary capacity. If a bank is offering virtual currency custody services in a non-fiduciary capacity, the bank is acting as a bailee and is responsible for safekeeping the asset while legal title remains with the bank’s customer. In order to provide broader virtual currency services in a fiduciary capacity, a bank must possess trust powers, which might require a charter amendment in addition to complying with the specific provisions of the Texas Administrative Code.
Offering a novel service with unique risks in accordance with safe and sound banking practices requires significant expertise. As with many high-risk bank activities, it is often prudent to rely on service providers that have developed the requisite expertise and technology systems in order for a bank to offer new services in an efficient manner. The notice specifically acknowledges that banks may leverage third party service providers to offer virtual currency services, provided that the bank maintains a strong third party risk management program to address and monitor the risks involved in such a relationship.
The decision of whether to offer virtual currency activities begins with a careful evaluation of the risks by both the management and board of directors of a bank. The notice emphasizes that “should management and the board of directors decide to move forward, effective risk management systems and controls must be implemented to measure, monitor, and control relevant risks associated with custody of digital assets.”
Texas has taken a deliberated approach towards evaluating virtual currency activity under the state’s financial services regulatory framework. Texas issued a supervisory memorandum in 2019 that made it one of the first state banking regulators to take the position that virtual currency activity is not considered money transmission under the Texas Money Services Act.
This latest notice is particularly timely because the Governor of Texas signed a law on June 12th that inserts a definition of “virtual currency” in the state’s commercial code. The new law also provides a clear and concise framework for establishing control over virtual currency.
While it is clear that Texas state-chartered banks should feel confident with respect to the legal authority to provide virtual currency services, it is equally clear that examiners will expect banks to develop comprehensive, documented, risk management frameworks in order to demonstrate that such services can be offered in a safe and sound manner.
Industry notices do not carry the force of law, but encompass changes in policies, procedures, urgent messages, general news and events, and other similar newsworthy information.