The launch of the Fed’s instant payment FedNow system has raised the value of access to master accounts–which Kraken Bank, Custodia Bank and others haven’t been granted.
By Emily Mason, Forbes Staff
In July, the Federal Reserve launched FedNow, its first new payments system in 50 years. This promising new platform could eventually give businesses and consumers near instant access to payments (including paychecks) and money moved between financial accounts, while spurring innovation in the sector.
But there’s a catch: to get direct access to FedNow and other Fed services (including FedWire, for same day money transfers), an institution has to be approved for a “master account” by one of the 12 regional Federal Reserve Banks. Yet as fintech, crypto and other novel financial startups have gotten state banking charters and sought approval for these master accounts, they’ve encountered delays and outright rejection, leading to regulatory and political jousting–and inevitably, litigation. The long anticipated debut of FedNow, with all its potential, raises the stakes in this battle.
It’s no mystery why the upstarts want to get approved for accounts. “A master account is essentially the giant pipeline through which the bank accesses Fed operated payment systems,’’ says Erin Fonte, a banking and fintech regulation partner at law firm Hunton Andrews Kurth.
If payment companies, fintechs and crypto firms can’t get that pipeline access, it could stifle their innovation—or at least force them to go through bank partners, which means kicking back some of their transaction fees to traditional banks. The Fed, for its part, is interested in making sure the newcomers–and innovations–don’t threaten financial stability.
In June, under Congressional pressure for transparency, the Federal Reserve posted a public database of recently approved, rejected and still pending master account applications. The only two rejected applicants shown in the database – Custodia Bank and PayServices – have already sued, challenging the legality of their rejections. In 2020, Custodia got a Wyoming Special Purpose Depository Institution Bank Charter issued under a 2019 state law designed in part for institutions that wanted to hold both crypto and traditional currencies. Custodia aims to serve as a bridge bank between digital assets and the traditional financial system. PayServices, for its part, is a fintech with a preliminary Idaho state bank charter that is focused narrowly on facilitating international money transfers for the export and import of commodities by small and medium sized businesses.
The new database also shows 28 pending applications. One of the oldest was filed in October 2020 by Kraken Financial, which has a Wyoming SPDI charter and is affiliated with Kraken, the world’s third largest cryptocurrency exchange. Commercium Financial, a Wyoming SPDI intending to offer banking services for digital asset businesses, has had an application pending since May 2022. BankWyse also holds an SPDI charter and is listed as pending approval, though it only began the application process a few months ago.
Meanwhile, in August 2022, citing the “uptick in novel charters” being issued or considered by state and federal banking authorities, the Federal Reserve published final guidelines describing how the Reserve Banks should review master account applicants. At the start of what was a contentious rulemaking process, the Fed emphasized its goal was to protect the safety and soundness of the banking system, as well as to protect consumers and promote a safe, innovative payments system.
The guidelines created three buckets for applicants. Tier 1 applicants have Federal Deposit Insurance Corp. coverage and should receive minimal scrutiny before being granted a master account, the guidelines state. Tier 2 applicants may not have FDIC insurance, but are federally regulated (including having a holding company subject to Federal Reserve oversight) and receive an intermediate level of scrutiny. As for Tier 3 applicants, they don’t have FDIC insurance and typically have state charters, meaning they’re not otherwise subject to federal oversight. Tier 3, the guidelines stated, will be subject to “the strictest level of review’’ before being granted master accounts.
While some commentators on the Fed’s proposed guidelines had argued that no Tier 3 institutions should get master accounts, potential Tier 3 applicants complained that the proposed guidelines were too subjective, gave the Reserve Banks too much discretion and didn’t clearly spell out what they needed to do to get master accounts.
“They will serve as hollow justifications for denial,” Kraken wrote in a July 2021 letter commenting on the then proposed guidelines. “Given their vagueness, these denials could be based on any number of grounds that are just as likely to be politically-driven as prudential. Even then, there are no assurances that Reserve Banks will apply the factors consistently.”
Now that the final guidelines are out and little changed, Kraken Bank CEO Trevor Rutar is no happier. “It’s unclear how The Fed is going to approve these applications,” he told Forbes. “There hasn’t been a single bank approved from Tier 3 so we’d like some clarity and transparency on that and why our application as well as others has taken so long to be decided. Those things need to be moving forward or at least some clarity provided by the Fed.” Kraken is in ongoing conversations with the Federal Reserve about its application, Rutar says.
Notably, of the 28 institutions whose master applications are listed as “pending” on the Fed’s database, 16 are Tier 3.
The Wyoming SPDI license held by Kraken Bank (also called Payward Financial) authorizes it to receive deposits, custody assets or transact on behalf of customers, but not to lend. It isn’t FDIC insured, but it must hold 100% reserves for any crypto assets in its custody.
That’s the same reserve requirement for crypto that Wyoming imposes on all SPDIs, including Custodia, which finally had its master account application denied by the Federal Reserve Bank of Kansas City in January 2023, 27 months after it was first submitted—and after it had sued demanding a decision. The Federal Reserve Board of Governors also denied its membership application for the Federal Reserve System, a step which would have subjected it to federal regulatory oversight—essentially moving it to what is now Tier 2. In its order denying Custodia membership in the Federal Reserve System, the Fed pointed to its lack of FDIC-insurance, an undiversified business focused on the niche industry of digital assets and concerns over the bank’s management team.
“Custodia has been unable to demonstrate that it could conduct an undiversified business focused on crypto-asset-related activities in a safe and sound manner and in compliance with BSA and Office of Foreign Assets Control (OFAC) requirements,” the rejection order reads.
In its lawsuit, Custodia argues that it and other SPDIs are owed access to a master account under a 1980 law that requires the Federal Reserve to provide its services to all eligible depository institutions. It also alleges the denial threatens the U.S. dual banking system, in which both states and the federal government have authority to charter and regulate financial institutions. Wyoming, Custodia says in its suit, developed the SPDI charter in close partnership with the Kansas City Federal Reserve Bank, in an effort to foster innovation in the state by offering digital asset businesses banking options. Now, it contends, the Federal Reserve has interfered with that process and undermined the state’s discretionary authority by denying it access to a master account and, by extension, Federal Reserve bank services including direct access to FedWire and FedNow. Without a master account, Custodia must rely on a third-party banking partner to offer its planned suite of digital asset services.
While Wyoming SPDIs handling crypto have become a central tension point in the question of master account access, the issue affects a broader set of fintechs as well. PayServices had its application denied in May 2023, nearly a year after submitting it for approval. In June, it sued the Federal Reserve Bank of San Francisco arguing it is entitled to a master account as an eligible depository institution with a preliminary state charter from Idaho. PayServices says it doesn’t need–and Idaho doesn’t require it to get–FDIC insurance because its business model doesn’t involve making loans or granting credits.
“Without a master account, PayServices Bank is relegated to depending on an intermediary bank, which prevents it from managing the settlement of transactions and services related to foreign trade that it has uniquely positioned itself to handle,” the complaint states.
Also in the master account database’s pending category are two upstarts aiming to make international payments more streamlined and competitive: Acceleron and Banking Circle US. Acceleron has a temporary charter as an uninsured depository institution in Vermont. It helps banks and credit unions route foreign exchange transactions through the cheapest wire provider, introducing choice and competition for smaller institutions that typically rely on a single provider like Wells Fargo to handle their international wires. Master account access would allow Acceleron to transact directly with its bank clients to route international wire funds on their behalf. It does not plan on holding deposits for clients, which is why it does not have FDIC insurance.
“We’re waiting for that master account because then we can clear directly and that way it’s less moving parts,” Sarah Beth Felix, co-founder and chief anti-money laundering officer of Acceleron Bank (in formation), says. “That master account really would allow us to do what we set out to do five plus years ago, which is to have an easier process for these community institutions.”
Acceleron’s master account application has been pending since August 2022. It was designated a Tier 3 applicant when the new guidelines were introduced. “At first it was a little daunting because it was like ‘shoot, that means I’m going to be like 60 years old by the time this gets approved,’” quips Beth Felix, who is 44. Still, she adds, as a compliance executive, she understands why the Fed has an approach to evaluating candidates that emphasizes risk. “That’s the world I live in,’’ she says.
Banking Circle US is another Tier 3 institution whose master account application has been pending since November 2019. It holds a European banking license and a bank charter in Connecticut. Banking Circle provides a platform helping businesses make cross border payments and counts Stripe, Alibaba and Checkout.com among its clients, according to its website.
Caitlin Long, founder and CEO of Custodia Bank, figures that if one of the pending Tier 3 applicants is approved, it will open the floodgates and generate interest from larger fintechs like PayPal or Stripe to seek banking charters and master account access. “The moment one of those domestic financial institutions that are eligible breaks through, then you should expect that the big fintechs will pursue that option,” Long says.
The launch of FedNow has fintechs eager to develop products utilizing the infrastructure and driving real-time payments adoption, but they need a clear pathway to connect, observes John Wilson, product manager of enterprise payments at FIS, a technology provider for financial institutions and businesses.
“The Fed is hearing from their customers that they want to be able to use the service in any function that fits to drive adoption,” Wilson says. “That would be your consumer products, remittances, for example, all of these pieces that are specific use cases. Fintechs are finding solutions for these use cases and rather than going through a sponsor bank they want to go directly to it.”
The Fed says its new tier ranking system is designed to protect the financial system and consumers, which is why those banks with FDIC insurance have an easy path to master accounts. Most of the pending fintech applicants are uninsured and have state charters or specialty charters like an SPDI from Wyoming. But another new Fed database of existing master account holders shows 414 of them also lack FDIC insurance. Notably, these are largely traditional financial institutions like credit unions or federal home loan banks.
The Federal Reserve and the Office of the Comptroller of the Currency (which oversees banks with national charters) are clearly still developing their approach to fintechs and digital asset businesses. On Tuesday, the Federal Reserve Board of Governors announced the creation of a Novel Activities Supervision Program to oversee new technology-focused bank services. The program will focus on digital asset banking and partnerships between banks and technology companies. Fintechs often rely on partnerships with traditional banks to provide the back-end infrastructure for their offerings.
One concern the Fed may have with pending master account applicants is their focus on specific industries. The run on Silicon Valley Bank in March, which brought about its sudden failure, was catalyzed by a concentrated pool of customers, venture backed tech startups, who were prone to social media-fueled collective action. The ability to transfer funds from a bank account online, as opposed to physically going to a bank branch to withdraw money, has sped up digital-age bank runs. Instant fund transfers, such as those enabled by FedNow, could make banks even more vulnerable to sudden events.
If fintechs are determined to gain master account access and the Fed doesn’t relent (or isn’t forced by the courts to do so), there’s another option, of course. The newcomers could take on the expense and regulatory burden of obtaining a national bank charter. Varo Bank, a digital bank offering a savings account, credit builder card and small loans, holds a national banking charter and has master account access. But Varo has struggled to reach profitability. Stripe competitor Adyen holds a European banking license and a federally issued U.S. branch license. In fact, thanks to its banking license, Adyen was the only fintech on the list of early FedNow adopters.
“A lot of people have tried to crack the code of having a limited purpose bank that doesn’t have to meet all the obligations that a normal bank has to,” Fonte, of Hunton Andrews Kurth, says. “That’s really difficult to do because if you are going to play in the sandbox, the regulators are gonna require you to have minimum things up and running and you can’t really hack your way around compliance.”
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