“Banks labor under heavy, and in almost every important way, unchecked regulation,” he wrote in a June article in the Iowa Law Review. This situation, according to Zaring, challenges the “basic assumptions of American administrative law,” including the idea that transparency, regular judicial review and cost-benefit analyses all make for better regulations.
“The banking regulatory regime features none of these regulatory basics,” Zaring wrote.
The Federal Reserve, which after the financial crisis of 2008 became the nation’s most important banking regulator — in addition to its role as the federal government’s fiscal agent and implementer of monetary policy — is to a large degree unburdened by oversight.
Congress does not control the Fed’s budget, the White House does not vet Fed regulations like it does for other agencies, and the staggered 14-year terms of Fed governors and a tradition of central-bank independence mean even the president has limited influence.
What’s more, because regional Fed banks are private entities, federal courts have less power to check their decisions, and they are not subject to transparency laws like the Freedom of Information Act.
Zaring argues that the unique nature of bank regulation stems from the government’s interest in providing U.S. businesses with credit and from the ever-present danger that the banking system can go haywire as it did in 2008, “with consequences well beyond the investors and managers of a bank that fails.”
The basic agreement, then, is that banks submit themselves to the imperial powers of the Federal Reserve and other regulators, and in return they get access to Fed infrastructure like risk-free accounts and payment rails — as well as the implicit promise that they will be bailed out if things really go haywire.
This deal may be well and good for incumbent financial institutions, but the example of PayServices raises the question of who gets to decide which banks are dealt into this system of intense regulation and generous subsidies — and which banks are left out in the cold.
Operation choke point 2.0
The Reserve Trust episode only exacerbated concerns that many lawmakers had been expressing over the Fed’s failure to grant master accounts to novel banks, like Four Corners Bank, a Colorado institution that was started in order to serve the needs of cannabis businesses after the state legalized recreational use in 2012.
National banks have long refused to serve cannabis businesses in states where the substance is legal to use, given that it remains illicit at the federal level, saying that banking services for those who traffic in marijuana would violate anti-money-laundering laws.
It’s the cryptocurrency industry, however, that some believe is driving the Fed’s increasing reluctance to offer master accounts to state-chartered institutions.
Caitlin Long, the founder and CEO of Custodia, a recently opened Wyoming depository institution that offers bitcoin and ether custody and dollar payment services, first applied for a Fed master account in 2020. The application was denied in January.
Long told MarketWatch that, like Danenberg, she felt her company was making progress with the Fed in its application and that she was “blindsided” by the denial of the account.
In its lawsuit against the Fed, Custodia describes the denial as a “coordinated maneuver orchestrated by the [Fed] Board in consultation with the White House,” in a political climate that had become increasingly anti-crypto following the failure of cryptocurrency exchange FTX.
Nic Carter, a general partner at the crypto-investment company Castle Island Adventures, believes that the federal government is broadly cracking down on the crypto industry through regulatory measures that he calls “Operation Choke Point 2.0,” referencing the Obama-era scandal over banking regulators’ moves against the payday-lending industry.
“There’s a distinct policy at the federal level to marginalize the crypto space and limit its access to the financial system,” Carter told MarketWatch, adding that companies in the industry struggle to get access to basic banking services, a trend that has only worsened since the failure of two banks associated with the crypto industry earlier this year: Silvergate and Signature Bank of New York.
The Biden administration’s turn against the crypto industry has been anything but subtle. As recently as last May, industry insiders were optimistic that a Biden executive order on digital assets that touted the “potential benefits of digital assets and their underlying technology” was a signal that the White House would take a balanced approach to crypto.
But since that time, the Treasury Department has sanctioned Tornado Cash, a decentralized finance, or DeFi, protocol that enables users to obfuscate transactions on the Ethereum blockchain, and in April, it published an exhaustive report on the threats DeFi poses to efforts to combat money laundering and funding of illicit activities.
In January, the Fed, in conjunction with the FDIC and the Office of the Comptroller of the Currency, issued a warning on the threat of crypto to the banking system, stating that they would be “carefully reviewing any proposals from banking organizations to engage in activities that involve crypto assets.”
Meanwhile, Democrats in Congress appear to have abandoned bipartisan efforts to write crypto-specific financial regulations as the Securities and Exchange Commission has brought enforcement actions against the world’s two largest crypto exchanges: Binance and Coinbase (COIN).
Wyoming Sen. Cynthia Lummis, a Republican, told MarketWatch in a statement that Wyoming’s bank charter law fully complies with the Federal Reserve Act, and therefore it has no basis to deny Custodia a master account.
“By repeatedly denying master accounts to institutions that custody crypto assets, the Federal Reserve is failing in its responsibility to ensure crypto assets are properly regulated and the risks are managed,” she said. “These decisions are more about politics than bank regulation.”
End game
Danenberg worries that PayServices has gotten caught in the crossfire in the battle over crypto policy, but also that federal regulators’ negative attitude toward crypto is illustrative of broader skepticism of financial innovation.
“The Fed has kind of started to awaken to the fact that there is new stuff coming to market that makes the old model obsolete,” he said, adding that the incumbent banks that own shares in the regional Fed banks have little incentive to welcome new models for providing financial services.
Other noncrypto-banking companies are also fighting the Fed in the courts, with the latest suit filed in July by the Puerto Rican bank whose master account was revoked by the Federal Reserve Bank of New York over concerns about compliance with U.S. sanctions and anti-money-laundering laws.
Dozens more are waiting for their applications to be reviewed, with little information as to when or why they will be accepted or denied.
Hill, the scholar at the University of Alabama, believes that the law is on the side of those banks fighting for a master account and that the Fed does not have the discretion to deny eligible banks access to accounts and payment services.
At the very least, she said, the Fed must be more transparent about why it’s accepting some applications and denying others.
“Take the Custodia example,” she said. “We can guess that the Fed doesn’t want to do it because it’s crypto-related, but we don’t really know because they won’t say.”
-Chris Matthews
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08-21-23 1528ET
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