S&C Publication: Federal Reserve Revises Policy on Permissible Activities for State Member Banks

Summary

On December 17, the Federal Reserve Board rescinded its 2023 Policy Statement interpreting Section 9(13) of the Federal Reserve Act, which had effectively precluded all state member banks from engaging as principal in activities that are not permitted for national banks or insured state-chartered banks.[1] At the same time, the Board ordered the withdrawal of the Federal Register preamble text that had accompanied the 2023 Policy Statement, which had described in particularly restrictive terms how the 2023 Policy Statement would apply to particular crypto-asset activities, such as holding crypto-assets as principal.[2] In place of the 2023 Policy Statement, the Federal Reserve adopted a new Policy Statement that articulates a more permissive approach to defining the scope of activities that may be engaged in by state member banks, if authorized under state law.[3] This action represents a further step in the broader liberalization of the approach taken by the Federal Reserve and other federal banking agencies toward digital asset-related activities.[4]

Legal Framework and Policy Statement

Under Section 9(13) of the Federal Reserve Act, a state member bank may “exercise all corporate powers granted it by the State in which it was created … except that the [Board] may 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 [(the “FDIA”)].”[5] Section 24 of the FDIA and Part 362 of the FDIC’s regulations in turn generally prohibit insured state banks (including insured state member banks) from engaging as principal in any type of activity that is not permissible for national banks, unless the FDIC has determined the activity would not pose significant risk to the Deposit Insurance Fund, and the insured state bank continues to be in compliance with applicable capital standards.[6] National banks are granted certain enumerated powers by the National Bank Act, as well as “all such incidental powers as shall be necessary to carry on the business of banking,” as determined by the OCC.[7]

The Federal Reserve’s 2023 Policy Statement established a presumption that the Federal Reserve would exercise its discretion under 9(13) to restrict both insured and uninsured state member banks to those activities that would be permissible for national banks under the National Bank Act and OCC regulations—subject any terms, conditions and limitations placed on national banks by the OCC, including any requirement to obtain supervisory preclearance—or for insured state banks under the FDIA and Part 362 of the FDIC regulations.[8]

The Federal Reserve’s new Policy Statement replaces the 2023 Policy Statement in its entirety. The text of the new Policy Statement continues to prohibit insured state member banks from engaging in any activity not permitted to national banks except to the extent allowed by the FDIC, although it makes clear that no separate application to the Federal Reserve is required for an insured state member bank to do so. The new Policy Statement directs insured state banks to apply to the FDIC in the absence of statutory or regulatory authority to engage in an activity, and does not require any additional application to the Board.[9] Accordingly, the Federal Reserve will defer to the FDIC’s individualized determinations with respect to the permissibility of the activities of insured state member banks going forward.

With respect to uninsured state member banks (or new or existing uninsured state banks that might consider applying for Federal Reserve membership), the new Policy Statement represents a more significant shift. As in the 2023 Policy Statement, uninsured state member banks seeking to exercise a power granted under state law are instructed to look first to the OCC’s rules governing national banks and the FDIC’s rules governing insured state banks. In the absence of authority from either source, an uninsured state member bank must seek permission from the Federal Reserve to engage in the activity under Section 208.3(d)(2) of Regulation H, which deals with changes to the general character of the member bank’s business or the scope of the corporate powers it exercises, or in its application to obtain Federal Reserve membership.[10] Under the 2023 Policy Statement, the Federal Reserve would have presumptively denied that permission absent a “clear and compelling rationale for the Board to allow the proposed deviation in regulatory treatment among federally supervised banks.”[11] By contrast, under the new Policy Statement, the Federal Reserve will assess such requests more permissively, considering “whether the uninsured state member bank would be capable of engaging in such activity in a safe and sound manner,” taking into account the bank’s regulatory framework, the risks of the proposed activity, and how the bank would mitigate risks posed by the lack of deposit insurance.[12]

Although the 2023 Policy Statement, on its face, applied to all activities in which a state member bank might wish to engage, it was clearly focused on the risks of “crypto-asset-related activities” and was accompanied by preamble text setting out the Federal Reserve’s position that many such activities, including “holding most crypto-assets, including bitcoin and ether, as principal in any amount,” would be presumptively prohibited for state member banks.[13] In rescinding the 2023 Policy Statement, the Federal Reserve has also withdrawn the guidance contained in that 2023 preamble text “given its evolving understanding of the risks of the crypto-asset sector and its desire to facilitate innovation in a manner consistent with safety and soundness and preserving the stability of the U.S. financial system.”[14] The withdrawn guidance includes the statement in the 2023 preamble that the Federal Reserve Board “generally believes 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.”[15]

Implications

The 2023 Policy Statement, which was unanimously adopted by the Federal Reserve Board at the time, was expressly justified by reference to the principle that “the same bank activity, presenting the same risks, should be subject to the same regulatory framework.”[16] The 2023 Policy Statement sought to apply the powers limitations applicable to national banks and insured state banks uniformly to state member banks, whether insured or uninsured, on the basis that there should be a level playing field in terms of available powers among all federally supervised banks. In adopting the new Policy Statement, the Federal Reserve Board has emphasized what it describes as the corresponding “reciprocal principle” of “different activity, different risks, different regulation” to adopt a very different substantive position “designed to facilitate innovation by state member banks.”[17]

The new Policy Statement represents a further step in the broader liberalization of the approach taken by the Federal Reserve and other federal banking agencies toward digital asset-related activities. For insured state member banks, the Federal Reserve’s indication that it will defer to the FDIC’s determinations regarding permissible activities and will not require a separate application for permission to engage in such activities may contribute to a clearer path to more extensive digital asset-related activity by insured state member banks, especially when combined with other recent actions taken by the FDIC and other banking agencies. For new or existing uninsured state banks, including those which engage in crypto-asset activities, the new Policy Statement and the accompanying preamble may suggest greater receptivity by the Board to applications for Federal Reserve membership by uninsured state banks engaged in such activities.

In what may be considered a thematically similar action, the Federal Reserve on December 19 released a request for public input and comment on a prototype for special purpose Federal Reserve Bank “payment accounts” that would be available to eligible financial institutions without a full-service Federal Reserve Bank “master account.”[18] Under the payment account proposal, uninsured state member banks that may potentially be empowered under the new Policy Statement to exercise a broader scope of state-granted powers would also be eligible to receive a payment account. Moreover, to the extent the new Policy Statement makes it easier for uninsured state member banks that intend to exercise broader state-granted powers to gain Federal Reserve membership, it would correspondingly enable some of these institutions to be accorded Tier 2 rather than Tier 3 status under the Federal Reserve Account Access Guidelines, potentially improving their prospects to be granted a Federal Reserve account in some form.[19]