Payments Report: News from Washington, Brought to you by NEACH
VOLUME 2023-7 (SEP 23)
Overview: In August, the Federal Reserve Board of Governors (“FRB”) issued two supervisory letters that collectively describe the FRB’s updated program to supervise bank activities that involve crypto assets and blockchain technology. One of the supervisory letters also describes the process that banks must follow before engaging in activities involving stablecoins, which includes obtaining a nonobjection from its Federal Reserve supervisors.
Background
In January 2023, the FRB, Federal Deposit Insurance Corporation (“FDIC”), and Office of the Comptroller of the Currency (“OCC”) issued a joint statement concerning crypto assets. The joint statement indicated the agencies were evaluating the risks associated with crypto assets, and assessing how banks could engage in activities involving crypto assets in a safe and sound manner and in compliance with applicable law.
The FRB subsequently issued its own policy statement later in January 2023 indicating that state banks supervised by the FRB will be subject to the same limitations on activities, including crypto-asset-related activities, as national banks supervised by the OCC. Under prior Interpretive Letters 1174 and 1179, the OCC stated that any national bank seeking to issue a stablecoin would need to meet several conditions, including demonstrating that the bank has controls in place to conduct the activity in a safe and sound manner. A bank would also need to receive the OCC’s approval before commencing such activity, which the OCC would provide in the format of a supervisory nonobjection letter. The FRB policy statement adopted the same standard for FRB supervised banks. However, the FRB policy statement did not describe how Federal Reserve supervisors would assess a request for approval of crypto-asset-related activities, or the process for submitting such a request.
Federal Reserve Guidance on Approval Process for Stablecoin Activity
On August 8, 2023, the FRB published Supervision and Regulation Letter 23-8, which describes the approval process for FRB supervised state banks seeking to engage in activities involving stablecoins. A bank seeking to issue, hold, or transact in stablecoins, including for purposes of testing, must notify its lead supervisory point of contact at the Federal Reserve of the bank’s intention to engage in the proposed activity and provide a description of the proposed activity. A bank may only engage in the activity after receiving a written notification of supervisory nonobjection and will be subject to heightened monitoring of these activities.
To obtain a supervisory nonobjection, a bank will be required to demonstrate that it 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 on an ongoing basis. Federal Reserve supervisory staff will focus their review on the following categories of risk:
- Operational risks, including risks associated with governance and oversight and the transaction validation process;
- Cybersecurity risks, including risks associated with the network on which the stablecoin is transacted, the use of smart contracts, and any use of open-source code;
- Liquidity risks, including the risk that the stablecoin could experience substantial redemptions in a short period of time that would trigger rapid outflows of deposits;
- Illicit finance risks, including risks relating to compliance with money laundering and sanctions requirements; and
- Consumer compliance risks, including risks related to identifying and ensuring compliance with any applicable consumer protection statutes and regulations.
Federal Reserve supervisory staff will also assess the bank’s overall compliance posture, including that it understands and will comply with all applicable law.
The letter directs FRB-supervised banks that were already engaged in stablecoin activities prior to the release of the letter to notify their lead supervisory point of contact. Such banks may continue to engage in the existing activities while Federal Reserve supervisory staff considers whether to provide a supervisory nonobjection for those activities.
FRB Creates Novel Activities Supervision Program
The FRB also issued Supervision and Regulation Letter 23-7 on August 8, 2023. This letter describes the creation of the FRB’s new Novel Activities Supervision Program (the “Program”), which will focus on activities related to crypto-assets, blockchain technology, technology-driven partnerships with nonbanks, and banks concentrated in providing traditional financial services to crypto-asset-related entities and fintechs.
Federal Reserve staff will notify banks whose novel activities will be subject to examination through the Program, and periodically evaluate which banks should be subject to the Program. Banks engaged in novel activities will not be moved to a separate category of supervision. Rather, the Program will supplement and work alongside existing supervisory teams to monitor and examine novel activities conducted by banks.
The letter states that the Program will be risk-based, and the level and intensity of supervision will vary based on the level of engagement in novel activities by each bank. It will be advised by a range of multidisciplinary leaders from throughout the Federal Reserve System as well as external experts from academia and the financial services and technology industries. However, the letter does not provide further detail on which staff will be assigned to the Program or how it will be organized.
Outlook: The FRB’s two new Supervision and Regulation Letters provide additional clarity for FRB supervised banks seeking to engage in stablecoin and other novel activities. However, these new FRB programs will come with enhanced scrutiny and supervision, and it is likely that banks will need to make a strong showing to obtain supervisory staff’s approval to engage in novel activities.