The Lummis-Gillibrand crypto bill provision that has banks on edge

A bipartisan bill aiming to establish a broad framework for regulating digital assets could make it easier for financial technology companies to access Federal Reserve bank accounts.

The Responsible Financial Innovation Act, introduced by Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., on Tuesday morning, includes a provision stipulating that any depository institution with a state charter is entitled to an account at a Federal Reserve bank, regardless of whether they are federally insured or supervised.

This puts the bill in the middle of a contentious dispute between traditional banks and their tech-based competitors. 

Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., unveiled a bill Monday that would comprehensively integrate blockchain technology into the financial regulatory system, but it would also broaden the universe of entities entitled to a Federal Reserve master account.

Bloomberg News

Bank industry groups, which have been calling for a federal oversight requirement since the Fed began reviewing its master account process last year, argue that section 702 of the legislation would make it easier for non-banks to access the central bank’s payment, clearing and settlement services as well as segregated balance accounts than traditional banks.

Sarah Grano, a spokesperson for the American Bankers Association, said the provision creates a “parallel supervisory and regulatory structure” that not only advantages fintechs, but also puts traditional banks and consumers at risk. The industry group supports a uniform supervision policy for all master account holders, she said.

“We believe Chair [Jerome] Powell’s principle of ‘like activity, like regulation’ should guide this debate, and we look forward to sharing our perspective as the legislative process plays out,” Grano said in an email.

Paige Pidano Paridon, the Bank Policy Institute’s senior vice president and associate general counsel for regulatory affairs, said the provision appears to strip away the ability of the Fed’s Board of Governors to determine which institutions are fit to receive access to the central bank and the protections that come with it. 

“This would make getting a Fed account a right, essentially, whereas the Fed has long held the position that it is discretionary for the Fed to grant access to an applicant that applies for services and a master account,” she said. “The legislation doesn’t appear to provide any framework for or speak to any ability of the Fed or the reserve banks to impose requirements or conditions on access.”

The Lummis-Gillibrand bill asserts that attempts by the Fed to clarify which institutions could be granted reserve bank accounts and the review process they must face to do so cut against the central bank’s Congressional mandate to provide access to all depositories. 

“Certain novel legal positions that conflict with or frustrate these precedents are not in the best traditions of the Federal Reserve Act, our dual banking system, and the imperatives of Congress,” the bill reads. 

Aaron Klein, a senior fellow in economic studies at the Brookings Institution, said this stipulation is a response to individual reserve banks that have rejected account applications from certain state-chartered entities in recent years. He cited the example of Fourth Corner Credit Union, a Colorado-chartered institution that was denied an account with the Kansas City Fed after a protracted application process. The rationale was that Fourth Corner served the cannabis industry, which is legal in its home state but illegal federally. 

“Taken together, the legislation is a clear shot across the bow of the Fed, particularly the Kansas City Federal Reserve Bank, which has repeatedly used novel legal arguments to deny eligible entities access to master accounts,” Klein said.

Isaac Boltansky, director of policy research at the financial services firm BTIG, said section 702 will be a battleground issue in the months — and potentially years — ahead, as federally-supervised banks look to protect their position as the sole holders of Fed accounts.

“Access to the Fed is one of the last meaningful moats for the traditional banking industry,” Boltansky said.

The consensus view among analysts and industry insiders is that the Lummis-Gillibrand bill is unlikely to be signed into law during this Congress. With midterm elections less than five months away and a litany of other, more pressing matters to attend to, Stephen Aschettino, head of fintech at the law firm Norton Rose Fulbright, said the odds of this or any other crypto legislation reaching President Joe Biden’s desk are slim.

“There is a limited timeframe, it’s an election year and one could argue that issues like gun control, and maybe privacy should be or are ahead of this,” Aschettino said. “But I’m hoping it’s something that does initiate robust, bipartisan discussion, and if it’s something that is not passed this year, it can be passed in some form next year”

Others say a codified regulatory framework could be even further away from implementation. 

“We’re years away from having legislation in this space, unless there’s an unexpected market catalyst,” Gabriel Rosenberg, a partner at the law firm Davis Polk focused on fintechs and crypto, said. 

Still, the Lummis-Gillibrand bill is being lauded by both advocates and opponents as a watershed moment for the crypto industry. Along with being the first piece of digital asset legislation to be sponsored by both a Democrat and a Republican, it is also among the most encompassinging proposals put forth to date, ranging from defining key terms to outlining a tax regime for the space. 

“This is one of the first serious and comprehensive proposals, which I think is going to be a base for everything that comes after it,” Rosenberg said.

The package calls for the Fed to conduct a study on how distributed ledger technology, commonly referred to as blockchain, might be used to reduce risk and cut capital requirements for banks. It also outlines how banks can handle custody accounts for digital assets, creates a tailored holding company supervisory framework for non-depository stablecoin issuers and allows for all chartered depository institutions to issue their own payment stablecoins.

The framework sets a one-year time limit for the Fed to process account applications. It would also require the Fed to report a list of applications that have been pending for nine months or longer to Congress. 

Dennis Kelleher, president and CEO of the consumer advocacy group Better Markets, agrees that the Lummis-Gillibrand bill will likely be the starting point for conversation around regulating digital assets going forward, but noted that this opening bid does not bode well for the banking industry or consumers.

“There are numerous provisions throughout the proposed legislation that would essentially inject crypto throughout the mainstream banking system,” Kelleher said. “This raises considerable concerns about financial stability, access to Fed bailouts and, ultimately, risks for taxpayer bailouts. This is essentially the legitimization of a product that is largely a speculative gambling product.”

Kelleher added that the prospect of allowing crypto companies access to Fed accounts is one of the many ways the Lummis-Gillibrand legislation jeopardizes the financial system, comparing it to the 1999 repeal of the Glass-Stegall, which separated commercial and investment banking and created the Federal Deposit Insurance Corporation.

“One of the problems of this town is that the word ‘bipartisan’ often acts like pixie dust to blind people to significant shortcomings in legislation,” Kelleher said. “The question should not be whether or not it has bipartisan support, but whether or not it’s an incredibly dangerous idea to basically not regulate one of the most volatile, speculative, dangerous financial products to come along since credit default swaps, which did not end well for this country in 2008.”

The legislation was applauded by numerous cryptocurrency companies for providing regulatory clarity without threatening to stifle innovation. Opponents say the crypto-friendly framework serves to legitimize the industry rather than rein it in.

“Under-regulated crypto markets have become a playground for scammers, tax dodgers and black market traffickers,” Bartlett Naylor, financial policy advocate at advocacy group Public Citizen, said in a statement. “While we appreciate the senators’ recognition that crypto regulation is broken, their bill would formalize the regulatory avoidance and arbitrage that the industry has relied on to grow so far.”

The Lummis-Gillibrand bill distinguishes which assets should be treated as securities and which should be considered commodities within the digital space. Based on its guidelines, the bulk of tokens in the market today would fall under the jurisdiction of the Commodity Futures Trading Commission rather than the Securities and Exchange Commission, the latter of which has taken a more aggressive stance toward policing the industry to date.

“We see this as a political problem,” Jaret Seiberg, the financial services and housing policy analyst for Cowen Washington Research Group, wrote in a policy note Tuesday. “It is hard for us to see Senate Banking or House Financial Services ceding jurisdiction over much of crypto to the agriculture committees, which oversee the CFTC. It is why this bill is the start of the serious discussions [of digital asset regulation]. It is not the end of them.”

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