Yesterday the US Congressional Research Service (CRS) published a paper about policy issues relating to the Federal Reserve. Around one fifth of the document covered crypto and digital currency topics. It outlined a number of policy questions that Congress might wish to consider. Two related questions were: “Should crypto firms and other nontraditional firms with federal or state bank charters be granted direct access to the Fed’s discount window and master accounts? Should Congress determine who gets access through legislation or defer to the Fed?”
The Congressional Research Service is a non partisan government organization. Hence, it doesn’t propose policy but outlines topics that Congress might wish to consider.
Crypto access to master accounts?
The question regarding master accounts follows the legal battle between Custodia Bank and the Federal Reserve, after the Fed first delayed a response and then refused a master account. Custodia Bank never planned to grant loans, so deposits would be backed one for one and therefore it did not seek FDIC insurance.
The paper quotes the Fed in its refusal as saying,
“[T]he future earnings prospects of the business model that Custodia has proposed—that is, an uninsured, undiversified, crypto-asset-focused business model featuring a number of novel and untested activities posing heightened risks – is inconsistent with approval.”
Despite the paper questioning whether the choice should be taken away from the Fed, it also refers to a District Court ruling against Custodia:
“[U]nless the Federal Reserve Banks possess discretion to deny or reject a master account application, state chartering laws would be the only layer of insulation for the U.S. financial system. And in that scenario, one can readily foresee a ‘race to the bottom’ among states and politicians to attract business by reducing state chartering burdens through lax legislation….. States lack not only the mission but also the resources to protect national interests.”
The paper also covered three other topics:
- Bank engagement with crypto (including crypto sector de-banking)
- Stablecoins
- Central bank digital currency
Bank engagement with crypto
The paper observes that bank engagement with crypto faces a two-pronged test:
- is the activity permissible under the law?
- is it safe and sound?
The authors note that “Federal banking regulators have significant discretion over both findings, and their interpretation has changed under different leadership.”
Under the first Trump administration, banks needed to demonstrate activities were safe and sound, whereas the Biden leadership imposed case-by-case approval. Eventually the Fed stated that banks are ‘presumptively prohibited’ from holding crypto as principal as it does not believe they can do so in a safe and sound manner.
Moving on, there’s been much discussion about the de-banking of the crypto sector, which was touched upon briefly and is now subject to Congressional hearings.
Some of the questions it poses to Congress include:
- Are some crypto activities inherently too risky for banks or BHCs (bank holding companies) to participate in, as evidenced by the failures of banks with crypto exposure in 2023?
- Are limits on traditional bank services provided to the crypto industry necessary from a safety and soundness perspective, or are they unfairly discriminating against the crypto industry? Is rulemaking needed to ensure equal treatment, or are the current rules well suited to recent developments?
- Are crypto activities part of or incidental to the business of banking as required for it to be a permissible activity? Does crypto provide some public benefit or purpose that warrants bringing it inside the federal bank safety net? Should Congress make it explicit that they are or are not permissible activities?
That last point is saying if banks were allowed to engage with crypto on their own behalf (rather than just for clients), given the potential for an adverse knock on effect to the bank as a whole, it will impact the safety net.
Stablecoins and CBDC
Unfortunately the paper’s coverage of CBDC failed to distinguish between wholesale and retail CBDC at all. As we’ve previously noted, wholesale CBDC could be beneficial to the banking sector without raising the privacy concerns relating to retail CBDC.
The paper also noted President Trump’s executive order to terminate work on a CBDC. However, the Federal Reserve is supposedly an independent agency. Hence, the authors note:
“CRS (Congressional Research Services) cannot locate any statement from the Fed on whether it intends to terminate its research in response to the executive order. Congress might choose to legislate in order to either explicitly authorize or mandate the Fed to create a CBDC and shape its features.”
On the topic of stablecoins, the paper notes that banks were allowed to get involved provided they do so in a safe and sound manner. However, they observe that the Fed:
“generally believes that issuing tokens on open, public, and/or decentralized networks, or similar systems is highly likely to be inconsistent with safe and sound banking practices.”
The authors highlight that the net effect is to prevent banks from getting involved in stablecoin issuance. While they note that banks can participate in tokenized deposits, they don’t mention that this has also been patchy, with multiple initiatives blocked under the Biden administration.
Amongst the policy issues raised, they ask whether stablecoins should have FDIC insurance. The questions they ask for stablecoins include:
- Should payment stablecoins or all stablecoins be regulated for safety and soundness?
- Should banks, nonbanks, or both be permitted to issue stablecoins given financial stability concerns? If so, should bank issuance be limited to payment stablecoins?
- Should stablecoins have access to federal deposit insurance, Fed master accounts, and the Fed’s discount window?