Grygo is the chief content officer for FTF & FTF News.
In early August, the Federal Reserve Board let the banks know that it is keeping an eye on their “novel activities” such as those involving crypto-assets and distributed ledger technology (DLT) otherwise known as blockchain systems.
“The Federal Reserve Board on Tuesday [Aug. 8] provided additional information on its program to supervise novel activities in the banks it oversees,” according to the Fed’s announcement.
Simply put, the Fed is watching for the good and the bad that innovation can bring.
“The goal … is to foster the benefits of financial innovation while recognizing and appropriately addressing risks to ensure the safety and soundness of the banking system. The program will be integrated into the Federal Reserve’s existing supervisory processes, with program experts working alongside current supervisory teams to oversee banks engaged in novel activities,” according to the announcement.
The Fed also provided “additional information on the process for a state bank supervised by the Federal Reserve to follow before engaging in certain dollar token or stablecoin activity, including demonstrating to its Federal Reserve supervisors that it has appropriate safeguards to conduct the activity safely and soundly,” according to the Fed.
In a letter signed by Michael S. Gibson, director, Division of Supervision and Regulation, and Eric S. Belsky, director, Division of Consumer and Community Affairs, the Fed spelled out how to get a “written notification of supervisory nonobjection” for dollar tokens or stablecoins.
A state member bank must demonstrate appropriate risk management practices for the proposed activities, including:
- “Operational risks, including those risks associated with the governance and oversight of the network; clarity of the roles, responsibilities, and liabilities of parties involved; and the transaction validation process (e.g., timing and finality of settlement of transactions, potential irreversibility of transactions, and the central authority of transaction records);
- “Cybersecurity risks, including risks associated with the network on which the dollar token is transacted, the use of smart contracts, and any use of open source code;
- “Liquidity risks, including the risk that the dollar token 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 Bank Secrecy Act and Office of Foreign Asset Control requirements, which include requiring banking organizations to verify the identity of a customer, perform due diligence to understand the nature and purpose of the customer relationship, and perform ongoing monitoring to identify and report suspicious activity; and
- “Consumer compliance risks, including risks related to identifying and ensuring compliance with any consumer protection statutes and regulations that apply to the specific dollar token activity.”
“Federal Reserve staff will also assess whether the bank has demonstrated that it understands and will comply with laws that apply to the proposed activities,” Gibson and Belsky add.
To provide more information about overall supervision, Gibson penned a letter and sent it to “all banking organizations supervised by the Federal Reserve, including those with $10 billion or less in consolidated assets.”
In his letter, Gibson offers more detail:
- “Complex, technology-driven partnerships with non-banks to provide banking services” are partnerships “where a non-bank serves as a provider of banking products and services to end customers, usually involving technologies like application programming interfaces (APIs) that provide automated access to the bank’s infrastructure;”
- “Crypto-asset related activities” covers “crypto-asset custody, crypto-collateralized lending, facilitating crypto-asset trading, and engaging in stablecoin/dollar token issuance or distribution;”
- “Projects that use DLT with the potential for significant impact on the financial system – The exploration or use of DLT for various use cases such as issuance of dollar tokens and tokenization of securities or other assets;”
- Concentrated provision of banking services to crypto-asset-related entities and fintechs – Banking organizations concentrated in providing traditional banking activities such as deposits, payments, and lending to crypto-asset-related entities and fintechs.”
The new program will “ leverage current supervisory processes to the extent possible to maximize efficiency and minimize burden,” Gibson says.
The new 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 supervised banking organization,” Gibson says. “The Federal Reserve will notify in writing those supervised banking organizations whose novel activities will be subject to examination through the Program.”
Those in the new program “will be advised by a range of multidisciplinary leaders from around the Federal Reserve System. To stay abreast of emerging issues, technologies, and new products, the Program will engage broadly with external experts from academia and the banking, finance, and technology industries,” officials say.
“The Program will incorporate insights and analysis from real-time data, market monitoring, horizontal exams, and proactive, intentional, and regular information exchange across portfolios, federal bank regulatory agencies, and other stakeholders,” the Fed notes.
Ultimately, there is a strange irony here. The Fed is acknowledging the potential and the harm of the cryptocurrency movement, which has been fueled by a deep antipathy toward central banks and a belief in the power of chaos. I’m wondering if the new program is sending a signal to the crypto warriors that central banks are not going away any time soon.
All of which makes me look forward to more news about the Central Bank Digital Currency (CBDC) coming from the Fed and the CBDCs from other central banks.
More details about the new program can be found here: https://bit.ly/3OAUAKd
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