Less than one month after the Federal Reserve Board of Governors closed the comment period on its proposal to set up a payment prototype account tailored to the needs of crypto firms, the Federal Reserve Bank of Kansas City on March 4 took the bold step of awarding such an account for a term of one year to Payward Financial, doing business as Kraken Financial. That entity is chartered in Wyoming as a special purpose depository institution, which means it does not offer loans and is not insured by the Federal Deposit Insurance Corp.
Kraken did not return a request for comment. But the company did publish a blog post in recognition of the historic milestone. “With a Federal Reserve master account, we can operate not as a peripheral participant in the U.S. banking system, but as a directly connected financial institution,” said Arjun Sethi, Co-CEO of Payward and Kraken, in the post.
The Crypto Council for Innovation (CCI), which advocates for inclusive regulation on behalf of the crypto industry and counts Kraken as a member, had advocated for such access in a Feb. 6 comment letter supporting the Fed Board’s proposal. “These innovations stand poised to unlock benefits for American consumers, including lower transaction costs, expanded access to financial services and increased customer choice,” reads the letter written by George Leonardo, policy counsel for the CCI.
Both Kraken Financial’s master account approval and the speed with which it was awarded have left banking groups surprised and confused. Brian Laverdure, senior vice president of digital assets and innovation policy for the Independent Community Bankers of America (ICBA), says it leaves his members with more questions than answers. “I think community bankers expected a lot more thoughtful and deliberate analysis of all those comments before any sort of action would result,” he says. “So, yeah, I think they’re puzzled.”
What is equally puzzling even to some outside experts is that one of the Fed’s regional reserve banks would take this step before the Fed finalized its proposal. David Zaring, a professor of legal studies and business ethics at the University of Pennsylvania’s Wharton School, submitted a comment letter in favor of the Fed’s skinny master account proposal. But he was also caught off guard by the Kansas City Fed’s action. “One thing that’s been going on in this space is this weird sort of dance between the Board of Governors, which sets the rules of the road for access to master accounts, and the various reserve banks which make individualized decisions about applications for master accounts that come their way,” he says. “And it looks to me like there wasn’t a ton of coordination here.”
For the ICBA and other banking groups, it remains unclear what limits have been placed on Kraken Financial’s master account or whether other skinny accounts will be approved before their access runs out.
A Question of Access
FinXTech first wrote about skinny master accounts in November, just weeks after Fed Board Gov. Christopher Waller first expressed his support for the concept in an October 21 address to the Fed’s Payments Innovation Conference. Waller said such an account would provide access to the Fed’s payment rails while controlling for various risks. “To control the size of the accounts and associated impacts on the Fed’s balance sheet, the Reserve Banks would not pay interest on balances in a payment account, and balance caps may be imposed,” he said.
Waller also clarified that skinny account holders would not be allowed to access a Fed service that provides overdraft protection to some master account holders during business hours, and would not be eligible for discount window borrowing, which banks and credit unions access to manage liquidity.
The proposal Waller spearheaded is modeled after those comments. It seeks to set up a prototype account specifically for what it classifies as Tier 3 institutions, which assume more risk and are not insured by the FDIC. It would provide master account access to them for the limited purpose of clearing and settling payments.
But the Kansas City Fed specifically noted in its press release on Kraken Financial’s master account that, “Due to the confidentiality of business information provided by applicants, the Kansas City Fed does not disclose specific information about account holders’ access to the range of Federal Reserve financial services.”
David Schroeder, senior vice president of federal governmental relations for the Community Bankers Association of Illinois (CBAI), says that lack of transparency is concerning. “It has national implications,” he says. “As a result, there should be a more uniform effort at looking at these applications and then [providing] greater transparency to address what are legitimate industry concerns about what this authority does and does not impart upon the applicant.”
Even if Kraken Financial is only getting access to a master account in order to clear and settle payments, the ICBA, CBAI and other banking groups still have concerns about the impact that might have on their members and the greater financial system.
A Dangerous Precedent?
By having the ability to clear and settle payments with the Fed, crypto firms would not have to rely on correspondent banks to provide that service. In CCI’s comment letter, Leonardo extolled the benefits of that policy. “Expanded access to Federal Reserve payment services will spur innovation by reducing costs for banking institutions and their customers, allowing these funds to be repurposed for building new products, expanding into new markets, and hiring new workers,” the letter reads.
But correspondent banks also handle a number of compliance obligations inherent to the clearing and settling of such payments, including those related to anti-money laundering as mandated by the Bank Secrecy Act. Laverdure says that helps maintain the integrity of the nation’s financial system. “That is a valuable service,” he says. “And so without that, those responsibilities don’t just evaporate. They hope they don’t evaporate, right? They’re just going to fall on these novel entities. So, are they going to have the expertise, the manpower, to manage them effectively? That’s a perfectly valid question.”
The University of Pennsylvania’s Zaring agrees that does present a potential risk, but believes it is manageable for the Fed. He also thinks it will ultimately benefit consumers. “That’s going to lower costs,” he says. “So, that’s a good thing. It increases competition.”
The CBAI’s Schroeder says that the compliance burden is being underestimated. “To think that those responsibilities are not going to cost these institutions if they go out on their own, I think, is naive and that will impact their profitability,” he says.
Banking groups argue that those compliance concerns, a lack of insurance and lower capital requirements make these firms too risky to trust with even a slimmed-down master account. “A lot of this has not been tested. This is again why we stress to the Fed, ‘If you want to go down this road, make it a true experiment,’” Laverdure says. “The public, the banking system should be able to see how well this experiment was conducted. Did it actually achieve the outcomes that were expected? And if it didn’t, well then that should be the end of it.”
One week after Kraken Financial received its approval, the American Bankers Association’s ABA Journal quoted Fed Vice Chair for Supervision Michelle Bowman as saying Kraken’s access would indeed be treated as a one-year pilot. “We’re trying to learn,” she said. Should problems arise, she added that “there are a number of ways we can address behaviors that are not consistent with having a master account.”
But as of this article’s publication, the Fed Board of Governors has not made any official announcement to that effect, and has yet to publish its final rule on skinny master account access.
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