The Federal Reserve rejected Wyoming-based Custodia Bank’s application for membership because of the digital bank’s reliance on the risk-laden crypto industry and its lack of safety measures to prevent a run on deposits, according to a March 24 report.
The 86-page order was publicly released nearly two months after the Federal Reserve Board first announced its rejection of Custodia’s membership application on Jan. 27. Custodia Bank, which applied to the Fed for a master account in 2020, is suing both the Federal Reserve Board and Federal Reserve Bank of Kansas City in response to their rejections.
The Federal Reserve listed numerous concerns over Custodia’s application, including that it plans to accept only uninsured deposits. The Fed has not accepted an uninsured depositor as a member since federal deposit insurance began 90 years ago.
Custodia’s board of directors and management team has limited bank-specific risk management experience, according to the Fed, and Custodia’s risk management practices and controls were deemed insufficient to comply with BSA requirements and U.S. sanctions.
“The proposal also presents potential concerns with respect to Custodia’s ability to be resolved safely and effectively upon failure,” the Fed stated. “Uncertainty regarding such an outcome could contribute to instability and run risk at a time of stress for Custodia.”
The Federal Reserve sees the crypto industry as being interconnected and volatile following the recent bankruptcies of Celsius, Voyager, BlockFi and FTX. Regulators have frequently outlined the security concerns they see in crypto. In a Jan. 3 joint statement, the Fed’s Board of Governors, the FDIC and the Office of the Comptroller of the Currency said that exposure to the crypto sphere “is highly likely to be inconsistent with safe and sound banking practices.”
In a statement following the release of the report, Custodia Bank noted that both its primary bank regulator, the Wyoming Division of Banking, and an independent compliance consultant both authorized it to launch last fall. The bank plans to hold $1.08 in cash to back every dollar that customers deposit.
“The recently released Fed order is the result of numerous procedural abnormalities, factual inaccuracies that the Fed refused to correct and general bias against digital assets,” Custodia Bank stated. “Rather than choosing to work with a bank utilizing a low-risk, fully-reserved business model, the Fed instead demonstrated its shortsightedness and inability to adapt to changing markets.”