The US Federal Reserve has denied Custodia Bank’s application for membership due to concerns over the bank’s involvement in the crypto industry. This decision was outlined in an 86-page report released by the Fed on March 24, 2023.
The Fed’s report cited concerns over the bank’s business plan being focused on a narrow sector of the economy, with a high concentration of activities related to the crypto industry. The report states that the Fed has concerns about banks that focus almost exclusively on offering products and services related to the crypto-asset sector, as it presents heightened illicit finance and safety and soundness risks.
The report also noted that Custodia Bank had not yet developed a sufficient risk-management framework for its proposed cryptoasset-related activities, nor had it addressed the highly correlated risks associated with its undiversified business model. The report stated that Fed’s members must align their risk management systems and controls with the activities described in their business plans.
If Custodia Bank were to be accepted as a member of the System, it would be further prohibited from running crypto-related services “given the speculative and volatile nature of the crypto-asset ecosystem” that is not consistent with the purposes of the Federal Reserve Act. The report stated that “Further, if the Board were to approve Custodia’s membership application, it would prohibit Custodia from engaging in a number of the novel and unprecedented activities it proposes to conduct—at least until such time as the activities conducted as principal are permissible for national banks.”
The report also highlighted that the Fed’s decision was based on the fact that Custodia Bank is an uninsured depository institution seeking to focus almost exclusively on offering products and services related to the crypto-asset sector. The Fed stated that this further elevated concerns due to the heightened illicit finance and safety and soundness risks associated with such activities.
In response to the Fed’s decision, Custodia Bank criticized the decision as shortsighted and an inability to adapt to changing markets. The bank claimed that perhaps more attention to areas of real risk would have prevented the bank closures that Custodia was created to avoid. The bank has vowed to turn to the courts to vindicate its rights and compel the Fed to comply with the law.
The Fed’s report on Custodia Bank’s membership application is the longest denial order to date, with a length of 86 pages. This is 14 times longer than its previous longest denial order and 41% longer than the Fed’s longest order on any subject, according to the bank.
The US Federal Reserve has denied Custodia Bank’s membership application due to concerns over the bank’s involvement in the crypto industry. The bank’s proposed cryptoasset-related activities were deemed to present heightened illicit finance and safety and soundness risks, and the bank had not developed a sufficient risk-management framework. While Custodia Bank has criticized the Fed’s decision, the bank is now prohibited from running crypto-related services if accepted as a member.
