The Fed’s blatant attempt to de-bank crypto companies is illegal

Al Drago/Bloomberg

The Federal Reserve’s strategy to de-bank innovators has risen to new heights that rob the public of its rightful opportunity to engage. Starting in late 2022, the Fed’s strategy to cut off the crypto industry from the banking system became illegal on February 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 cryptoasset-related activities, including holding cryptoassets as principal and issuing stablecoins.

Since the final rule was issued on February 7, three central banks in the crypto industry have collapsed or gone out of business: Silvergate, Silicon Valley Bank and Signature. Although Signature was shut down unexpectedly, despite its solvency, by the New York State Department of Financial Services, the FDIC has stepped in and excluding Signature’s digital asset business from the deposits that will be taken over by the acquiring institution. This is no accident, and the Fed’s recent move illustrates the evolution from an unstated policy to a stated policy and finally to a rule published in the Federal Register.

The evolution of this new policy — from a joint statement by federal banking regulators on Jan. 3 to a final rule barely a month later — indicates a strategy by the Fed board to issue substantive rules while avoiding the notice-and-comment process required by the Administrative Procedure Act. The APA ensures that the public has proper involvement in all federal regulatory regimes. Before federal agencies mandate compliance with new rules, the agency must allow the public to provide feedback and additional information so that the agency can carefully consider the various implications and impacts of the rule before it becomes final.

The final rule requires state member banks to look to federal laws 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 fact, the final rule mandates that federal rules supersede state rules when it comes to state member banks. For example, even if a state does not require prior approval before issuing a stablecoin, state member banks must receive a non-objection – 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, framed in the form of a rule rather than interpretive guidance, and typically needs to go through proper APA procedures before taking effect. It presents a rebuttable presumption—that is, a presumed conclusion that can be contradicted if evidence proves otherwise—that the Fed must use when determining whether a state member bank can 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 consistent with federal principles for safe and sound banking. This exists outside of current state regulatory processes and may infringe on state regulators’ ability to effectively regulate the banks that exist in their systems.

The last rule has the full force of law. Under proper procedure, the Fed would have issued a notice of proposed rulemaking consistent with the APA. It is settled law that the board cannot avoid TFO’s procedural requirements simply by saying that an action is just politics.

In crafting the final rule, the Fed asserts facts without public notice or commitment. This is unusual and contravenes the requirements of TFO. Typically, when an agency issues a notice of proposed rulemaking, the public can engage through public comment and provide data on the potential impact of the rule or other legal consequences.

How can the public assess the reasonableness of such a rule without insight into the Fed’s fact-finding process or the method by which the Fed made its actual decisions? Bottom line: The public, and those most affected by this rule, are left in the dark.

While the final rule may appear to be aimed at reducing systemic risk in the market, the Fed is actually creating more risk by creating insurmountable obstacles for state member banks and driving crypto transactions toward less safe, unregulated areas. By imposing unfounded safety and soundness concerns that remain untested by public stakeholders, the Fed effectively imposed a ban on crypto-related activities for state member banks, while depriving the public of the ability to meaningfully engage.

If the final rule was truly aimed at reducing risk in the market, the Fed would have followed 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 US banking system. Instead, the Fed has deprived the public of the opportunity to engage in the rulemaking process.

While the Fed’s latest rule is just one piece of the puzzle, it is the most extreme example of bank regulators’ discriminatory and illegal attempts to shut crypto out of the banking system. The message it sends is clear: “If you are a bank serving clients in the crypto industry, watch out or you will suffer consequences.” We saw these veiled threats play out with Signature, and we continue to see it become more difficult for businesses engaged in crypto-related activities to open new bank accounts.

The public should – and must – demand better.