When The Fed Said “No”, Custodia Bank Was Crushed!

It’s been a wild ride recently for Custodia Bank. They seemed so sure that the Federal Reserve would let them open as a “limited purpose custodial bank” – an entity without deposit insurance, but specifically designed to provide tech firms with a solution for cryptocurrency custody.

Nope. Not at all.

Turns out the Fed wasn’t too keen on the idea of Custodia Bank. After much deliberation, the Federal Reserve Board denied the application, sending shockwaves through the tech industry. But why was the Fed so opposed to the idea of Custodia Bank?

The Fed: We’re Still Skeptical of Narrow Banking

The Federal Reserve clearly had some reservations about Custodia Bank (and it’s not the first time they’ve shown this particular skepticism).

Taking a look at the official response from the Fed, the Board noted that allowing Custodia Bank to open as a limited-purpose custodial bank would be “inconsistent with statutory and regulatory requirements for protecting customers’ deposits.”
It’s worth noting that the main issue wasn’t so much the idea of cryptocurrency custody as it was with the idea of narrow banking – a type of banking that limits activities to a specific narrow sector of banking, such as online loan servicing or cryptocurrency custody.

Consider the following from a statement from the Fed:

“The Custodia Bank proposal raised a number of public policy issues, including the need to ensure the safety and soundness of the institution, consumer protections related to the deposits held at the facility, and the implications for use of the Federal Reserve payments system.”

Essentially, the Fed is leery of banks that only do one type of banking, particularly when that type of banking could be risky (cryptocurrency storage, in this case).

Some Questions For The Fed

Clearly, the Federal Reserve was unwilling to compromise when it came to the Custodia Bank application. But that raises some questions.

  • What if Custodia Bank had proposed to expand its services beyond cryptocurrency custody?

  • Would the Fed be willing to reconsider its decision if Custodia Bank could prove a greater commitment to consumer protection?

  • Could Custodia Bank (or any other narrow banking institution) eventually be approved by the Federal Reserve?

Only time will tell. And in the meantime, Custodia Bank will need to find a new way to achieve its goal of providing tech firms with a solution for cryptocurrency custody.

The Takeaway

The Federal Reserve’s rejection of the Custodia Bank application is a reminder that when it comes to banking, the Fed isn’t willing to sacrifice safety and soundness. The Fed’s continued push back against narrow banking is a sign that it understands the risks of allowing these types of banks to open – and it isn’t willing to take those risks.