The Federal Reserve's strategy to de-bank innovators has risen to new heights that deprives the public of its rightful opportunity to engage. Beginning at the end of 2022, the Fed's strategy to cut off the crypto industry from the banking system became unlawful on Feb. 7 when the agency issued a final rule without going through the required notice and comment procedures. The final rule imposes new obligations on state member banks regarding crypto-asset-related activities, including holding crypto assets as principal and issuing stablecoins.
Since the final rule was issued on Feb. 7, three banks central to the crypto industry have collapsed or been shut down: Silvergate, Silicon Valley Bank and Signature. Though Signature was shut down unexpectedly, despite its solvency, by the New York State Department of Financial Services, the FDIC has stepped in and
The progression of this new policy — from a joint statement from the federal banking regulators on Jan. 3 to a
The final rule requires state member banks to look to federal statutes and regulations to determine whether an activity is permissible for national banks. If there isn't a current applicable rule on the books, state member banks are required to obtain permission from the Fed — this could include permission to hold crypto-assets as principal or issue a stablecoin. In effect, the final rule mandates that federal rules supersede those of the state when it comes to state member banks. For instance, even if a state requires no pre-approval before issuing a stablecoin, state member banks must receive a nonobjection — a written letter stating that the regulator does not object to the activity — from federal regulators before engaging in that activity.
The final rule uses mandatory language, fashioned in the form of a rule rather than interpretive guidance, and which would ordinarily need to go through proper APA procedures before taking effect. It sets forth a rebuttable presumption — i.e., an assumed conclusion which can be contradicted if evidence proves otherwise — that the Fed must apply when determining whether a state member bank may engage in crypto-related activities. Before engaging in such activity, member banks must now demonstrate their "clear and compelling rationale" for engaging in the activity and provide evidence of risk management plans in accordance with federal principles of safe and sound banking. This exists outside of applicable state regulatory processes and may infringe on state regulators' ability to effectively regulate the banks existing within their systems.
The final rule carries with it the full force of law. Under proper procedure, the Fed would have issued a notice of proposed rulemaking in accordance with the APA. It is settled law that the board cannot avoid the APA's procedural requirements merely by stating that an action is simply policy.
In drafting the final rule, the Fed asserts facts without public notice or engagement. This is unusual and runs contrary to the requirements of the APA. Typically, when an agency issues a notice of proposed rulemaking, the public can engage through public comment and provide data as to the potential impact of the rule or other legal ramifications.
How can the public assess the reasonableness of such a rule without any insight into the Fed's fact-finding process or the method by which the Fed made its factual determinations? Bottom line: The public, and those who this rule impacts most, is left in the dark.
Though the final rule may seem like it's geared toward mitigating systemic risk in the market, in actuality, the Fed is creating more risk by posing insurmountable hurdles on state member banks and driving crypto transactions toward less safe, unregulated spaces. By imposing unfounded safety and soundness concerns that remain untested by public stakeholders, the Fed instituted an effective ban on crypto-related activities for state member banks all while depriving the public of an opportunity to meaningfully engage.
If the final rule were truly aimed at mitigating risks in the market, the Fed would have pursued an open rulemaking process to make it safer and easier for banks to engage in crypto-related activities rather than cutting off crypto activity from the U.S. banking system. Instead, the Fed has deprived the public of the opportunity to engage in the rulemaking process.
Though the Fed's final rule is only one piece of the puzzle, it is the most egregious example of the banking regulators' discriminatory and unlawful efforts to shut crypto out of the banking system. The message it sends is clear: "If you are a bank servicing clients in the crypto industry, watch out, or you will suffer consequences." We watched these veiled threats play out with Signature and we continue to watch as it becomes more difficult for businesses engaging in crypto-related activities to open new bank accounts.
The public should — and must — demand better.
