Fintechs, Novel Charters, and Fed Master Accounts—Of Elephants and Mouseholes

6 min

A U.S. District Court recently rejected arguments that banks and institutions with novel charters have a statutory right to obtain a Federal Reserve master account. Master accounts let institutions access key parts of the Federal Reserve's payments system. Entities that do not have master accounts generally need to have banking relationships with institutions that do have them, adding cost, friction, and other complexity to transactions. The court's decision stemmed from a lawsuit filed by Custodia Bank (Custodia), which applied for a master account in October 2020 but was denied by the Federal Reserve Board of Kansas City (FRBKC). The court agreed with the Federal Reserve Board (Fed) that the Fed has the discretion to grant or deny master accounts.

Key Takeaways

  • The Fed retains discretion to grant or deny master account applications. That means its August 2022 guidance establishing three tiers of review still applies. Essentially, federally insured banks are subject to streamlined review and are the most likely to have access. The court did not rule on or otherwise describe the limits to that discretion.
  • Fed master account approvals for entities other than tier 1 entities continue to stagnate, though recently it appears that some national trust banks have been granted access. Most others in tier 2 and tier 3 remain pending, others have been withdrawn, and a handful have been rejected. These other tiers entail institutions that have varying (i.e., lesser) degrees of federal prudential supervision.
  • Custodia could appeal the decision and still challenge the denial of the Fed membership. How this plays out on appeal is not clear. Although possible, it is also unclear whether Congress will eventually take further action to clarify its view of the statute.
  • Institutions that pursue novel charters should know that these charters may be met with regulatory and supervisory skepticism, criticism, or ambivalence at both the federal and state levels. In this framework, institutions with these charters may likely find it difficult to engage in certain activities that are available to their more traditional competitors.

Novel charter

Custodia is a Wyoming-based institution that focuses on digital assets, including cryptocurrency through a custody platform. It is chartered as a Wyoming Special Purpose Depository Institution (SPDI), which the Wyoming legislature created as a response to the growth of digital assets. While SPDIs may also focus on traditional assets, they are able to focus on digital assets, such as virtual currencies, digital securities, and digital consumer assets under Wyoming law.

In October 2020, the year it was chartered as an SPDI, Custodia applied to the FRBKC for a master account. Custodia also applied for Fed membership a year later to demonstrate "its willingness to submit to full federal supervision and accountability." On January 27, 2023, both applications were denied.

Discretion to reject equals discretion to deny

Custodia's lawsuit sought to compel both the Fed and the FRBKC to grant a master account to Custodia. Custodia claimed 12 U.S.C. § 248a(c)(2) requires FRBKC to provide a master account to all legally eligible depository institutions because the statute provides that "[a]ll Federal Reserve Bank services … shall be available to nonmember depository institutions."

The Fed, however, countered by citing its authority under 12 U.S.C. § 342, which gives the Board the discretion to receive deposits, arguing that the authority to receive deposits also comes with the discretion to receive or reject deposits (per a 1923 Supreme Court decision). The court extended this discretion to approving or denying master accounts. This approach is also in line with a recent ruling by the Southern District Court of New York that 12 U.S.C. § 342 does not mandate that Federal Reserve Banks maintain master accounts.

No support from the statutory text

The court also noted that the language of 12 U.S.C. § 248a does not support Custodia's claim. It does not mention "master account" but lists services covered by the fee schedule. The section also is not directed toward Federal Reserve Banks, but rather to the Board of Governors of the Federal Reserve System—looking to the subchapter's title for further clarification. The court reasoned that the goal of Section 248a is to create a non-discriminatory pricing schedule for member and non-member banks, not to provide master accounts to all eligible depository institutions.

The court also called attention to the placement of the adjective "all" in the statute. Congress put the word "all" before "services" but not before "nonmember depository institutions," suggesting that there is no discretion over which services are offered (or the fees charged per bank), but that discretion remains in allowing access to these services, such as granting master accounts.

Congress did not clearly intend to make such a big change

As part of the National Defense Authorization Act for Fiscal Year 2023, Congress required the Fed to create and maintain a public database of master accounts. In this master list of master accounts, the Fed has to identify every entity that has access to a master account, as well as every entity that has submitted an application for one. The database must also show applications that have been "approved, rejected, pending, or withdrawn."

The court outlined that the database mandate to include rejected applications would be at odds with Custodia's position that master accounts are a statutory right. If the Fed does not have any discretion in granting or denying master accounts, there would be no reason for Congress to require a public database of approved and denied applications.

The court also noted that since the Fed's creation, it has enjoyed and been understood as having discretion. If Congress intended to change a fundamental power that was created alongside the Fed itself, Congress would (or perhaps, should) have done so more clearly, according to the court. The court, however, did not decide exactly how much discretion the Federal Reserve Banks have in denying accounts.

Next Steps

Custodia has signaled that it is considering appealing the decision. Any review on appeal would likely look (de novo) at key elements of the decision, including whether Section 248 creates an express requirement for all legally eligible depository institutions, canons of construction (about titles and headings), and whether the use of "all" once, but not twice, fairly implies that Congress intended for the Federal Reserve Banks to have the discretion the court found. Issues surrounding the Administrative Procedures Act and the exact characterization of the Federal Reserve Banks as instrumentalities of the federal government (rather than agencies) may be factors too.

For now, tier 1 institutions under the Fed's 2022 guidance remain the most likely candidates for Fed master account access, as do some tier 2 institutions, such as national trust banks that engage in traditional fiduciary and related activities. But tier 3 institutions, such as Custodia, appear to be practically precluded.