MVA White Collar Defense, Investigations, and Regulatory Advice Blog

The Federal Reserve Board (“FRB”) rarely issues denials for applicants to become members of the Federal Reserve System. Senator Elizabeth Warren has even criticized the FRB for their number of approvals – although in the context of bank mergers. Last Friday Custodia Bank (state chartered in Wyoming) received such a denial. Custodia Bank was formed to be “a compliant bridge between digital assets and the U.S. dollar payments system” and a digital asset custodian.

One of the difficulties digital asset companies, like Custodia Bank, have faced is being able to access the payments and clearing system used by the traditional banking system. Wyoming (spurred to action by Caitlin Long, who also founded Custodia Bank) passed a bill that would create a “special purpose depository institution” (“SPDI”) that was largely modeled on existing licensing regimes for limited purpose trust companies, but that provided limited lending and deposit taking powers that would make getting FDIC insurance optional.

The practical effect was the creation of a limited purpose trust or custody bank, similar to a limited purpose trust company, that could state it had sufficient deposit taking powers to be eligible for FDIC insurance, but that the scope of its activities didn’t necessitate it. That nuance is important in terms of applying for a master account with the FRB since only depositories that were eligible for FDIC insurance would even be considered under the FRB’s operating circulars. This was the primary goal of the SPDI bank license regime: the creation of a novel charter type that could receive access to the Federal Reserve and payments system without having to also be subject to the same federal regulatory and supervisory regime as a bank.

In its release, the FRB stated Custodia Bank’s “novel business model and proposed focus on crypto-assets presented significant safety and soundness risks” and that Custodia Bank’s “risk management framework was insufficient to address concerns regarding the heightened risks associated with its proposed crypto activities, including its ability to mitigate money laundering and terrorism financing risks.” Interestingly, the FRB did not directly address the controversy around the novel charter type in its release.

Custodia Bank’s application almost certainly also faced difficulties given the change of administration, crypto winter, and many recently publicized bankruptcies related to crypto from well-known market participants. Further, the FRB’s and other federal banking regulators’ recent policy statements regarding digital asset activities make clear that the current administration views digital asset activities as something to “protect” the traditional banking system from, rather than invite in. It will also be interesting to read how the FRB’s Guidelines for Evaluating Account and Services Requests from August 2022 plays into the denial. For additional background on the policy statements issued by the agencies in August 2022, as well as the guidelines for evaluating master account applications, see our earlier blog post Risks Associated with Cryptocurrency Activities Continue to be Top-of-Mind for Federal Banking Regulators.

The FRB noted they will release the order following a review for confidential information.