New Fed Guidelines Clarify, But Do Not Transform, Master Account and Payment Services Access

The Federal Reserve Board recently issued final guidelines for the Reserve Banks to use in reviewing requests from a range of financial services providers for access to Federal Reserve master accounts and payment services. Master account and Federal Reserve services allow institutions to transfer money to other master accountholders directly and hold funds in the Federal Reserve System, while others must go through third parties — which can add cost, delay, and further complication to transactions.

The final guidelines are substantially similar to those proposed in 2021 and a supplement issued earlier this year. They make the application process more transparent by describing the risk factors that a Reserve Bank should take into consideration and by applying a three-tier approach regarding the intensity of a Reserve Bank’s review. However, the guidelines do not broaden the categories of entities that are eligible to apply in the first place, do not establish application processing timelines, and do not provide a clear path forward for entities that lack federal bank supervision, including novel charter types.

Key takeaways

• Many novel charters and other entities are still ineligible. An entity must meet the definition of “depository institution” in section 19(b) of the Federal Reserve Act, or be specifically eligible under another statute, to apply for a master account. That limits eligibility primarily to FDIC-insured institutions — or institutions eligible for FDIC deposit insurance — as well as insured credit unions and members of the Federal Home Loan Bank System.
  
  The Federal Reserve Board has not opened up a pathway to obtain master accounts and Federal Reserve services for other entities, including many state-licensed money transmitters, lenders, and others. Prospects for state-chartered special-purpose institutions (such as in Wyoming) are unclear, but they are not expressly barred by the final guidelines.
• Three tiers of review. Eligible entities will be placed in one of three tiers that specify the minimum level of scrutiny that the Reserve Banks are expected to administer when applying the risk-based principles described below. The more traditional the charter and the closer the entity is to direct supervision by the Federal Reserve, the more streamlined a Reserve Bank’s review is expected to be. However, the Federal Reserve specifically rejected requests that it establish an application review timetable, similar to some other applications. The Reserve Banks will instead still take a case-by-case approach, and applicants with novel businesses or arrangements should prepare for enhanced and extended scrutiny.
• Six risk-based principles. The final guidelines set forth six principles that provide a risk management framework for the Reserve Banks to apply. These principles range from narrower, microprudential risks to broader, macroprudential risks that touch on financial stability.
• An implementation plan will follow. The Reserve Banks are working in consultation with Federal Reserve staff to develop an implementation plan aimed at consistent application of the final guidelines.

Eligible institutions

Under Principle 1 of the final guidelines, the Reserve Banks will only consider applications by institutions that are legally eligible for access to Reserve Bank accounts and services. Legal eligibility, therefore, remains the key gating issue.

An entity is a legally eligible institution if it is a member bank of the Federal Reserve System or meets the definition of “depository institution” under section 19(b) of the Federal Reserve Act, unless it is otherwise specifically eligible by federal statute.

Section 19(b) of the Federal Reserve Act incorporates key definitions from the Federal Deposit Insurance Act that cover traditional FDIC-insured depository institutions, such as banks and savings associations. It also provides for insured credit unions and members of the Federal Home Loan Bank System. Significantly, depository institutions that are eligible to make an application to become an insured depository institution, but choose not to do so, may apply, but the Federal Reserve and the Reserve Banks maintain that they have the discretion, based on their risk assessment, whether to grant an account and services to such an applicant. Just because an institution is eligible does not mean that the Federal Reserve will grant it access. For instance, a Wyoming-chartered special-purpose institution has been in both application negotiations and litigation with the Federal Reserve over this very issue — and it remains unresolved.

Examples of eligible institutions are grouped below by review tier.

Three tiers of review

Eligible institutions can expect to undergo one of three levels of review under the final guidelines. All reviews will be on a case-by-case basis.

Many financial services companies appear to be ineligible, pending further determination or interpretation:

• State-licensed money transmitters (traditional services and crypto exchanges, even if registered as money services businesses with the Financial Crimes Enforcement Network)
• State-chartered non-bank mortgage lenders (even if participating in federal mortgage programs)
• Other state-chartered non-bank consumer lenders
• Broker-dealers
• Special-purpose state-chartered institutions (but see discussion below)
• Commercial entities (online marketplaces, vendors)

Special-purpose state-chartered institutions, such as those chartered in Wyoming, are not Tier 2 institutions because (1) they are not state-chartered institutions subject to Federal Reserve oversight (i.e., members of the Federal Reserve System, like some state-chartered trust companies), (2) they do not have holding companies that are subject to Federal Reserve oversight and (3) the question of their eligibility under section 19(b) of the Federal Reserve Act remains unresolved (discussed above). However, if the Federal Reserve Board were to approve membership in the Federal Reserve System for such an institution, it would be subject to Tier 2 review because it would be supervised by the Federal Reserve Board. Short of that, if a court or other authority with appropriate jurisdiction were to determine that they are in fact “depository institutions” for purposes of eligibility, they would be subject to Tier 3 review. Although the final guidelines do not provide a clear path forward for these institutions, they do not appear to absolutely bar them either.

The six principles for reserve bank review of requests

The Reserve Banks are expected to apply the following six principles. The first concerns legal eligibility, the other five concern risks both narrow and broad, encompassing both microprudential and macroprudential considerations.

Eligibility

• As discussed above, each institution requesting a master account or Federal Reserve services must be legally eligible to apply under section 19(b) of the Federal Reserve Act or another federal statute. The institution should have a well-founded, clear, transparent, and enforceable legal basis for its operations.

Risks

Provision of a master account and Federal Reserve services to an institution should not present or create certain risks to the:

• Reserve Banks (credit, operational, settlement, cyber, or other)
• Overall payment system (credit, liquidity, operational, settlement, cyber, or other)
• Stability of the U.S. financial system
• Overall economy (through facilitating money laundering, terrorism financing, fraud, cybercrimes, economic or trade sanctions violations, or other illicit activity)
• Federal Reserve’s ability to implement monetary policy

Eligible institutions that seek master accounts and Federal Reserve services should expect a robust risk-based review that looks at the institution’s compliance with applicable laws and regulations — including banking, consumer financial protection, and financial crimes laws and regulations. In addition, applicants should expect a thorough review of their own risk-management practices (e.g., credit, liquidity), the volume and complexity of their operations, and the extent to which they engage in novel activities.

If you have any questions regarding the guidance, please contact Katy Ryan, Max Bonici, or an attorney with whom you have worked in the past.