US Fed denies Custodia Bank membership over crypto concerns

In its 86-page report released on March 24, the US Federal Reserve denied Custodia Bank's application for membership citing concerns over the bank's involvement in the crypto industry. The Fed has raised "concerns about banks with business plans focused on a narrow sector of the economy", with a high concentration of activities related to the crypto industry. The report states that "Those concerns are further elevated with respect to Custodia because it is an uninsured depository institution seeking to focus almost exclusively on offering products and services related to the crypto-asset sector, which presents heightened illicit finance and safety and soundness risks."

The Fed also noted that Custodia Bank had not yet developed a sufficient risk-management framework for its proposed cryptoasset-related activities, nor had it addressed the highly correlated risks associated with its undiversified business model. The report stated that Fed's members must align their risk management systems and controls with the activities described in their business plans.

If Custodia Bank were to be accepted as a member of the System, it would be further prohibited from running crypto-related services "given the speculative and volatile nature of the crypto-asset ecosystem" that is not consistent with the purposes of the Federal Reserve Act. The report stated that "Further, if the Board were to approve Custodia’s membership application, it would prohibit Custodia from engaging in a number of the novel and unprecedented activities it proposes to conduct—at least until such time as the activities conducted as principal are permissible for national banks."

In response, Custodia Bank criticized the Fed's decision as shortsighted and an inability to adapt to changing markets. The bank claimed that perhaps more attention to areas of real risk would have prevented the bank closures that Custodia was created to avoid. The bank has vowed to turn to the courts to vindicate its rights and compel the Fed to comply with the law.

The Fed's report on Custodia Bank's membership application is 14 times longer than its previous longest denial order, and 41% longer than the Fed's longest order on any subject, according to the bank. In late January, the Fed denied a membership request from Custodia Bank, as well as a second application in February, claiming that its application "was inconsistent with the required factors under the law."

In conclusion, the US Federal Reserve has denied Custodia Bank's membership application due to concerns over the bank's involvement in the crypto industry. The bank's proposed cryptoasset-related activities were deemed to present heightened illicit finance and safety and soundness risks, and the bank had not developed a sufficient risk-management framework. While Custodia Bank has criticized the Fed's decision, the bank is now prohibited from running crypto-related services if accepted as a member.