The Board of Governors of the Federal Reserve System (Federal Reserve) took another tepid step into the digital asset space on August 8, announcing that it has established a program to “enhance the supervision of novel activities conducted by banking organizations supervised” by the Federal Reserve. In addition, the Federal Reserve issued guidance explaining the supervisory nonobjection process for state member banks “seeking to engage in certain activities involving tokens denominated in national currencies and issued using distributed ledger technology or similar technologies to facilitate payments.”
Noting that the goal of the novel activities supervision program is to “foster the benefits of financial innovation while recognizing and appropriately addressing risks to ensure the safety and soundness of the banking system,” the Federal Reserve indicated that its supervisory program will focus on what it views as “novel” activities related to the following:
- Cryptoassets, including cryptoasset custody, crypto-collateralized lending, facilitation of cryptoasset trading, and stablecoin/dollar token issuance or distribution activity
- Distributed ledger technology (DLT), such as the “exploration or use of DLT for various use cases such as issuance of dollar tokens and tokenization of securities or other assets”
- “Complex, technology-driven partnerships with non-banks to provide banking services,” which the Federal Reserve describes as certain partnerships where a non-bank serves as a provider of banking products and services to customers
- “Concentrated provision of banking services to crypto-asset-related entities and fintechs,” meaning banking organizations that are concentrated in providing traditional banking services to such entities
The Federal Reserve did not provide much new or meaningful guidance regarding precisely what types of activities would be “novel” or what types of relationships or products would rise to the level of “complex, technology-driven partnerships,” although the multiple mentions of application programming interfaces (APIs), DLTs, and crypto-related activities, entities, and fintechs, as well as the accompanying SR letter regarding activities involving dollar tokens or “stablecoins,” makes it clear that it remains focused on cryptocurrencies and “rent-a-bank” models.
The Federal Reserve explained that the program, like much of its supervision, will be risk-based, and that it will notify in writing which supervised entities will be subject to the program. The program will also be multidisciplinary in nature and seek perspectives from “external experts from academia and the banking finance, and technology industries,” and it will work within existing supervisory efforts; supervised entities that engage in novel activities will not be transferred to a separate supervisory portfolio.
In conjunction with the announcement of the novel activities supervision program, the Federal Reserve issued guidance to state member banks regarding the supervisory nonobjection process to engage in dollar-token-related activities. Specifically, any state member bank seeking to engage as principal in issuing, holding, or transacting in dollar tokens (also sometimes referred to as “stablecoins”), including for the purpose of testing, must “demonstrate, to the satisfaction of Federal Reserve supervisors, that the bank has controls in place to conduct the activity in a safe and sound manner” and receive written notification of supervisory nonobjection from the Federal Reserve before engaging in such activities.
Those familiar with the history from the early 2000s surrounding a bank’s ability to acquire equity securities as hedges for certain permissible derivative transactions will recognize many parallels to that supervisory non-objection regime in the Federal Reserve’s actions.
In order to receive supervisory nonobjection, a state member bank must notify its lead supervisory point of contact at the Federal Reserve of its intent to engage in dollar-token-related activities, describe the proposed activity, and demonstrate that the bank has “established appropriate risk management practices for the proposed activities, including having adequate systems in place to identify, measure, monitor, and control the risks of its activities, and the ability to do so on an ongoing basis.”
The Federal Reserve noted that, in considering whether to grant supervisory nonobjection, staff will focus on, among other things, operational risk, cybersecurity risk, liquidity risk, illicit finance risk, and consumer compliance risk. Staff will also evaluate whether the bank has demonstrated its compliance obligations with all relevant laws that apply to the proposed activity.
The announcement of the novel activities supervision program, as well as the guidance to state member banks on dollar-token-related activities, follows the Federal Reserve’s January 2023 policy statement clarifying that “uninsured and insured banks supervised by the [Federal Reserve] will be subject to the same limitations on activities, including novel banking activities,” as well as subject to limitations on certain activities imposed on national banks.
The Federal Reserve is, of course, not the only federal banking regulator to express concerns with the risks posed by digital asset activities. In November 2021, the Office of the Comptroller of the Currency (OCC) issued Interpretive Letter 1179, revising previous guidance on covered institutions’ cryptocurrency, DLT-related, and stablecoin activities as principal and mandating written supervisory nonobjection before a national bank or federal savings association can engage in such activities.
The Federal Deposit Insurance Corporation (FDIC) followed suit in April 2022 when, pursuant to FDIC FIL-16-2022, it required all FDIC-supervised institutions that intend to engage in, or were engaged in, crypto-related activities to provide prior notice to the FDIC and receive FDIC feedback regarding the safety and soundness of those activities and, effectively, nonobjection.
Similarly, in January 2023, the Federal Reserve, the OCC, and the Federal Deposit Insurance Corporation (FDIC) issued a joint statement warning of cryptoasset risks to banking organizations and stressing their “careful and cautious approach related to current or proposed crypto-asset-related activities and exposures at each banking organization.”
The Federal Reserve’s recent releases do not add much new to the existing conversation regarding bank-fintech partnerships or “novel” activities, although they are nevertheless notable because they evidence a continued sense of focus and concern regarding crypto-related activities and rent-a-bank relationships.
Importantly, the Federal Reserve specifically tied its supervisory nonobjection requirements to those activities “permitted for national banks under OCC Interpretive Letter 1174,” which at least implies that state member banks do not need nonobjection to engage in those cryptocurrency custody activities permissible under OCC Interpretive Letter 1170 (although, even if not required legally, state banks may still wish to provide advance notice as a matter of managing their supervisory relationship).
In any event, it is unlikely that we have heard the end of the federal banking agencies’ comments and concerns regarding “complex, technology-driven partnerships,” crypto-related activities, and how banks and other banking organizations may go about conducting those activities in a safe and sound manner. Stay tuned for more.