Federal Reserve Issues Policy Statement on Permissible Activities of State Member Banks
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This statement authorizes the Federal Reserve to “limit the activities of state member banks and subsidiaries of state member banks in a manner consistent with section 24 of the Federal Deposit Insurance Act,” setting out a rebuttable presumption that it will exercise its discretion under Section 9(13) to limit both insured and uninsured state-chartered banks that are members of the Federal Reserve System (“state member banks”) to engaging as principal in only those activities that are permissible for national banks, subject to the same terms, conditions and limitations placed on national banks with respect to the same activities, unless such activities are otherwise permissible for state-chartered banks by federal statute or under Part 362 of the regulations promulgated by the Federal Deposit Insurance Corporation (“FDIC”).2 Because insured state member banks are already directly subject to Part 362 by virtue of their insured status, this development is unlikely to have a material impact on insured state member banks.
By its terms, the Policy Statement applies broadly to any activities undertaken as principal by state member banks. However, the preamble to the Policy Statement highlights examples of how the Policy Statement would be applied to certain crypto-asset related activities, including holding crypto-assets as principal, issues that the Federal Reserve observed had been the subject of a number of recent inquiries.
Although the Policy Statement is directly applicable to state member banks, it should also be of interest to state-licensed branches of non-U.S. banks, whose activities are generally limited under federal law to those permissible for federally-licensed branches3 (whose activities, in turn, are limited to those permissible for national banks). While the Policy Statement does not address this issue, it is reasonable to assume that the Federal Reserve will apply the same principles outlined in the Policy Statement to the activities of state-licensed branches of non-U.S. banks.
In the U.S. dual banking system, banks can be chartered under either federal or state law. As a result, depending on the choice of federal or state charter, different legal and regulatory frameworks apply to national banks and state-chartered banks. Among the latter, aside from the differences in banking laws and regulations of the chartering states, other differences may also arise depending on whether the bank is insured or uninsured and whether or not it is a member of the Federal Reserve System. The applicability of different legal and regulatory frameworks may affect, among other things, the scope of permissible activities that may be conducted by a bank.
Permissible activities of national banks are established by the National Bank Act and the regulations and interpretations issued by the Office of the Comptroller of the Currency (“OCC”) pursuant to its authority thereunder. If an activity has not been authorized by the National Bank Act or the OCC’s regulations or interpretations, a national bank is not permitted to engage in such activity. For state-chartered banks, permissible activities are established by the applicable state law and the regulations and interpretations issued by the relevant state banking regulator pursuant to its authority under state law.
In general, activities permissible for state-chartered banks under state banking laws and regulations are similar to those authorized for national banks under the National Bank Act and the OCC’s regulations and interpretations, but they are not identical. The adoption of the Federal Deposit Insurance Corporation Improvement Act of 1991,4 which enacted Section 24 of the Federal Deposit Insurance Act (“FDIA”) to prohibit insured state-chartered banks from engaging as principal in any activity that is not permissible for national banks unless specifically authorized by the FDIC5 and the relevant provisions of Section 9(13) of the Federal Reserve Act and Section 7(h) of the International Banking Act of 1978, was largely prompted by serious challenges in the banking and thrift industries that occurred in the 1980s. Many failures were attributed, at least in part, to state laws that permitted financial institutions to engage in real estate and other non-traditional activities that were not permissible for national banks.
General principles outlined in the Policy Statement
To promote a level playing field among banks conducting the same activities, and to align the permissibility frameworks for uninsured and insured state member banks in order to mitigate the risks of regulatory arbitrage, the Federal Reserve outlined in the Policy Statement a clear expectation that state member banks look to federal statutes and OCC regulations and interpretations to determine whether an activity is permissible for national banks or if it has otherwise been authorized under Part 362 of the FDIC’s regulations.6 If there is no source of authority available for an activity under federal law or regulations, a state member bank may not engage in the activity without obtaining permission from the Federal Reserve under Section 208.3(d)(2) of the Federal Reserve’s Regulation H.7
The Federal Reserve indicated that it will rebuttably presume that a state member bank is prohibited from engaging as principal in any activity (including acquiring or retaining any investment) that is impermissible for national banks unless the activity is permissible for state-chartered banks under federal statute or Part 362 of the FDIC’s regulations. This presumption may be rebutted by the bank if there is a clear and compelling rationale for the Federal Reserve to allow the proposed deviation in regulatory treatment, and the state member bank has robust plans for managing the risks of the proposed activity in a safe and sound manner.
Safety and soundness considerations
The Federal Reserve emphasized in the Policy Statement that legal permissibility is a necessary, but not sufficient, condition to establish that a state member bank may engage in a particular activity. In addition, a state member bank must at all times conduct its business and exercise its powers with due regard to safety and soundness, which includes at a minimum having in place internal controls and information systems that are appropriate in light of the nature, scope and risks of its activities.
With respect to any “novel and unprecedented activities” (including those associated with crypto-assets or use of distributed ledger technology), it is particularly important for a state member bank to have in place appropriate systems to monitor and control risks, including liquidity, credit, market, operational (including cybersecurity and use of third parties) and compliance risks (including compliance with Bank Secrecy Act and Office of Foreign Asset Control requirements to reduce the risk of illicit finance activity). Federal Reserve supervisors will expect state member banks to be able to explain and demonstrate an effective control environment related to such activities.
Issues related to specific crypto-asset activities
The Policy Statement also makes clear the Federal Reserve’s intent to place significant restrictions on crypto-asset activities of state member banks.
Definition of “crypto-assets.” In the preamble to the Policy Statement, the Federal Reserve noted that the term “crypto-assets” refers to digital assets issued using distributed ledger technology and cryptographic techniques (such as bitcoin and ether) but does not include such assets to the extent they are more appropriately categorized within a recognized, traditional asset class, such as “securities with an effective registration statement filed under the Securities Act of 1933 that are issued, stored, or transferred through the system of a regulated clearing agency and in compliance with all applicable federal and state securities laws.” The Federal Reserve observed that, to the extent transmission using distributed ledger technology and cryptographic techniques changes the risks of a traditional asset (for example, through issuance, storage or transmission on an open, public and/or decentralized network or similar system), it reserved the right to treat the asset as a “crypto-asset.” This would presumably permit financial institutions to continue to manage tokenized assets on permissioned blockchain networks.
- Holding crypto-assets as principal. The Federal Reserve indicated in the preamble to the Policy Statement that it would presumptively prohibit state member banks from holding “most” crypto-assets as principal.8 The Federal Reserve explained that it has not identified any authority permitting national banks to hold most crypto-assets, including bitcoin and ether, as principal in any amount, and there is no federal statute or FDIC rule expressly permitting state banks to hold crypto-assets as principal.
The Federal Reserve further observed that the presumption against holding most crypto-assets as principal is bolstered by safety and soundness concerns, given, among other factors, the speculative nature of crypto-assets, the lack of appropriate regulation of the crypto-asset sector and the significant cybersecurity risks posed by crypto-assets that are issued or transacted on open, public and/or decentralized ledgers, especially in comparison to traditional asset classes.
“Dollar tokens.” The Federal Reserve stated in the preamble to the Policy Statement that any state member bank seeking to issue a dollar-denominated token to facilitate payments would need to adhere to the terms of the OCC’s Interpretive Letters 1174 and 1179, including the conditions imposed in such letters. The bank would also need to demonstrate to the satisfaction of the Federal Reserve supervisors that it has controls in place to conduct the activity in a safe and sound manner and receive a Federal Reserve supervisory non-objection before commencing such activity.
The Federal Reserve noted its general belief 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. Such tokens raise concerns related to operational, cybersecurity and run risks and may also present significant illicit finance risks because, depending on their design, such tokens could circulate continuously, quickly, pseudonymously and indefinitely among parties unknown to the issuing bank. The Federal Reserve observed that such risks are particularly pronounced where the issuing bank does not have the capability to obtain and verify the identity of all transacting parties, including those using unhosted wallets.
Custody of Crypto Assets Presumptively Permissible. The Federal Reserve indicated that nothing in the Policy Statement would prohibit a state member bank from providing safekeeping services for crypto-assets in a custodial capacity if such activities are conducted in a safe and sound manner and in compliance with consumer, anti-money laundering and anti-terrorist financing laws.
1. 12 U.S.C. § 330.
2. 12 C.F.R. Part 362.
3. Section 7(h)(1) of the International Banking Act of 1978, 12 U.S.C. § 3105(h)(1) (providing that a state branch or agency of a foreign bank may not engage in any type of activity that is not permissible for a federal branch unless the Federal Reserve has determined that such activity is consistent with sound banking practice and, in the case of an insured branch, the FDIC has determined that the activity would pose no significant risk to the deposit insurance fund). See also 12 C.F.R. § 211.29 (establishing an application process for state branches and agencies to seek approval of the Federal Reserve to conduct activities not permissible for federal branches).
4. Pub. L. 102-242 (Dec. 19, 1991).
5. The FDIC implemented the provisions of Section 24 of the FDIA in Part 362 of its regulations, 12 C.F.R. Part 362.
6. The Federal Reserve further noted that, in a case where a state member bank determines that an activity is permissible for national banks, the state member bank may only engage in the activity if the bank adheres to the terms, conditions and limitations placed with respect to the activity by the OCC on national banks.
7. 12 C.F.R. § 208.3(d)(2). The requirement to obtain the Federal Reserve’s approval under Regulation H does not supersede the separate obligation of an insured state member bank to seek approval of the FDIC pursuant to Section 24 of the FDIA and Part 362 of the FDIC’s regulations.
8. The sole exception identified by the Federal Reserve is the authority of national banks to hold stablecoins to facilitate payments, subject to the conditions imposed by the OCC in Interpretive Letter 1174 (Jan. 4, 2021) and Interpretive Letter 1179 (Nov. 18, 2021).