By Steve Kennelly
ABA point of view
IInnovation happens when creators find efficiencies, shortcuts, or backdoors that bypass obstacles that no longer belong. The Ford Model T assembly line found shortcuts in time that made it possible to mass-produce affordable cars. The credit card allowed merchants to bypass the process of validating the legitimacy of shoppers’ checks and allowed consumers to skip the process of getting and holding cash.
But not all backdoors are signs of innovation. Some of them are created by regulatory arbitrage – an effort to game the system and capitalize on weak points in the rules and laws that are meant to protect us all. And while some regulatory arbitrage efforts illuminate where we can modernize regulation, many others point to where a well-functioning regulatory structure needs to be strengthened.
Consider our payment system: it has worked well with the Federal Reserve Banks and its participants at regulated financial institutions, as all parties are held to the same high standards. However, over the past few years, some underregulated entities have sought to gain access to the Fed’s payment system, and this presents a risk that we simply cannot accept.
In Wyoming, a new type of charter for “Special Purpose Depository Institutions,” or SPDIs, was created to incentivize cryptocurrency companies to create state-chartered institutions that would perform certain banking functions, but without federal supervision or insurance. Instead of FDIC insurance, banks must have reserves to offset all deposits. Because there is no FDIC insurance, these entities are not subject to the Bank Holding Company Act.
Currently, there are two PSDI requests for payment system access pending with the Fed. This game of regulatory arbitration must be rejected. They seek to access the payment system without the oversight enjoyed by other participants in that same payment system. We urge the Federal Reserve to recognize this end of the race to avoid financial oversight, while seeking all the benefits that access to the payment system offers.
Consider a PSDI without federal oversight or insurance with access to the payment system. Without a federal agency or the FDIC looking over their shoulder, the deposits and privacy of bank customers are at risk. The same state agency that expedited these charters is charged with protecting the consumer. One of the SPDIs has a parent company that is a large cryptocurrency exchange, and without BHCA enforcement, there is no oversight of that relationship or the risks it poses.
There are also problems with some trust charters approved by the Office of the Comptroller of the Currency. At the end of the previous administration, the OCC issued an interpretative letter expanding the eligibility criteria for federal OCC trust charters, even if they do not plan to provide traditional trustee services.
The result is that several state-chartered trust companies that simply provide custodial services for digital assets have been granted conditional approval for a national charter from the OCC and are therefore on track to apply for the access to the Federal Reserve payment system. The OCC fundamentally changed the eligibility of trust charter applicants without public notice or a comment period. (Just this week, the OCC entered into a consent order with one of these companies for failing to adopt and implement an anti-money laundering compliance program.) a familiar arbitration game. Chartered institutions focused on digital assets without FDIC or BHCA oversight are seeking access to the payment system. This time it was done with the help of the OCC, although the OCC may not be so receptive to such endorsements anymore.
The Federal Reserve’s payment system has long worked well because all players were subject to consistent oversight and supervision. If these new charters are allowed access in their current form, we cannot be sure that the system will retain this strength and resilience. The innovation that exposes the payment system to greater risk is not a “disruption”. This is a direct error that the Fed can and should easily avoid.
Steve Kenneally is SVP for Payments System Policy issues at ABA.
ABA Viewpoint is the American Bankers Association’s source for analysis, commentary, and insights on the policy issues shaping the banking industry today and in the future. Click here to view all posts in this series.