Fed Master Accounts

An obscure yet critical part of US banking that's suddenly creating controversy and making headlines.

Hey friends —

Federal Reserve Master Accounts are a rarely discussed — but critical — part of banking in the US. Seemingly out of nowhere, they're now making headlines.

  • Pro-crypto Custodia Bank sues the Fed for ‘unlawful’ master account delay (Protos)

  • Should the Fed decide who gets a master account? (American Banker)

  • Republican senator says Fed has revoked master account for controversial fintech (Reuters)

  • Crypto Bank Custodia Sues Federal Reserve in a Long Shot to Get a Master Account (Futurum)

A Master Account is a bank account at the Federal Reserve. The headlines are about access — who’s eligible and what’s the review process.

Neither are clear. Both have led to controversy, lawsuits, and angry inquiries from Congress. We’re not in the clear yet — it’s a still evolving story and we’re diving in.

I'm indebted to Professor Julie Hill, thank you (🙏)! She's published a far more comprehensive account of Fed Master Accounts and kindly reviewed a draft of this letter.

In this week's letter:

  • Fed Master Accounts: sinking a Fed nominee, angering Congress, and riling up debate among banks and fintechs alike

  • Regulatory foundations of fintech, incredible images from space, and more cocktail talk

  • Captain’s Blood, a richer, deeper, more complex Daiquiri

Total read time: 10 minutes, 33 seconds.

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A Controversy That Was A Long Time Coming

Sarah Bloom Raskin is as accomplished an attorney and regulator as you'll find. Twice she served in top posts — as a member of the Board of Governors for the Federal Reserve from 2010 to 2014 and earlier as Deputy Secretary of the Treasury under Obama. She was unanimously confirmed by the Senate for both positions.

Biden nominated her as vice-chair for supervision of the Federal Reserve earlier this year. In March, Bloom Raskin withdrew her nomination.

What happened?

If you read the New Yorker or Bloom Raskin's letter, she faced "relentless attacks by special interests" for her stance that climate change could pose a threat to economic stability. There's truth to her charges.

Left unsaid was her involvement with startup Reserve Trust, a topic that featured prominently in her hearing.

Reserve Trust was founded in 2016 as a Colorado state-chartered trust. The company almost immediately applied for a Fed Master Account with the Kansas City Federal Reserve. In 2017, the application was denied.

Reserve Trust board member Bloom Raskin is alleged to have called Kansas City Fed Present Esther George. What's certain is that The Fed reversed its decision a year later and issued Reserve Trust a Master Account. In response to congressional inquiries, the Fed issued a single-page statement (emphasis mine):

The Kansas City Fed did not deviate from its review process in evaluating this request.

After this [original] denial, RTC changed its business model and the Colorado Division of Banking reinterpreted the state’s law in a manner that meant RTC met the definition of a depository institution. Because of these changes, and following a review of other risk-based factors relevant to the decision, the Kansas City Fed approved the RTC request for a master account in mid-2018.

It's a statement that didn't go over well with the Colorado Division of Banking (emphasis mine):

We consider the statement that the division ‘reinterpreted’ state law as a misrepresentation of our practice. The analysis of the laws is consistent, while what can change outcomes to our analysis are the facts provided by the entity.

The problem for the Fed is twofold: there’s no published process and the Reserve Trust has never been a depository institution. The startup describes itself as a "non-depository, Colorado chartered trust."

In response to a follow-up congressional inquiry in June, the Kansas Fed revealed that Reserve Trust's Master Account was revoked. It’s a story that’s continuing to unfold as the Kansas City Fed refuses to provide more insight into the decision-making process and members of the Senate Banking Committee get increasingly frustrated.

The crux of the problem is simple — there's almost no transparency around Fed Master Accounts. Eligibility is ambiguous. The review process that the Kansas Fed references isn't public. Even the list of who has a Master Account isn't known. It's a black box and a shocking oversight for such an important part of our banking system.

What is a Fed Master Account?

Think of a Fed Master Account as a bank account at the Federal Reserve. That might not sound like much, but it comes with two massive benefits.

First, it's about the only place an institution can store large sums of money with 100% fiat backing. Any other storage model introduces some type of risk. Even a vault full of paper currency risks failure in a natural disaster.

Second, Master Account holders get access to the full suite of payment services run by the Fed. That not only includes the more familiar ACH and check clearing services, but also Fedwire, a payment system for large electronic payments. Without a Master Account, institutions are stuck transferring money indirectly via correspondent banks.

With such little transparency around access, few have been vocal about its impact, but it's the primary reason QED led the $30.5 million Series A investment in Reserve Trust (emphasis mine):

Despite all the excitement around digital payments and infrastructure, there is still no fintech that can offer direct integration with the U.S. payment system. With Reserve Trust, we are creating foundational infrastructure to hold and move payments globally and at scale.

Moving money is at the heart of every business. Fedwire access means you can cut out middlemen even for large transactions — fewer fees and share less intimate data about your business. Access is hugely valuable.

But eligibility is anything but clear.

Who can get a Fed Master Account?

Let's start with who can't get Fed access — individuals. Beyond that, it gets murky.

12 U.S. Code § 342 states that "any Federal reserve bank may receive [deposits] from any of its member banks, or other depository institutions." Straight forward enough, but it then goes on to include "any nonmember bank or trust company or other depository institution" as well.

The language appears to grant the Fed discretion over which nonbank, trust, and other depository institutions it approves (emphasis mine):

Provided, Such nonmember bank or trust company or other depository institution maintains with the Federal Reserve bank of its district a balance in such amount as the Board determines taking into account items in transit, services provided by the Federal Reserve bank, and other factors as the Board may deem appropriate...

But a separate statute seemingly eliminates the Fed's discretion entirely (emphasis mine):

All Federal Reserve bank services covered by the fee schedule shall be available to nonmember depository institutions and such services shall be priced at the same fee schedule applicable to member banks...

Read through a lens that limits Fed discretion entirely, it appears that member banks, nonmember banks, trust companies, and other depository institutions are all eligible for Master Accounts. Certainly while Depository Trust and Clearing Corporation and Paxos were both granted access as state-chartered trusts, that interpretation seems stretched at best. It’s unlikely that the congressional intent was fully eliminate Fed discretion.

Until recently, this was all mostly a non-issue. Master Account requests were routinely approved. The instructions from the Fed on the one-page form agreement even state that "[p]rocessing [an application] may take 5–7 business days."

But it appears that the Fed's interpretation has changed.

Fed rejects master account applicants

In 2014, Colorado legalized retail sales of cannabis. Shortly thereafter, a group of entrepreneurs founded Fourth Corner Credit Union to provide banking services to retailers and others in the industry. As one does, they applied for a Master Account.

The Fed refused the credit union's application in 2015, stating (emphasis mine):

The court would not entertain other such attempts — such as if Colorado enacted a scheme to allow trade in endangered species or trade with North Korea in derogation of federal laws, and then chartered a credit union to handle the finances for companies conducting such illegal trade.” 

As long as cannabis remains illegal at the federal level, then the Fed won't allow state banks access if they support such illegal activities. It seems like a reasonable line to draw and one that's been supported by the courts. The outcome for the credit union has also been consistent with the guidance — the credit union later revamped its activities to only support ancillary businesses such as accountants and received conditional approval for a Master Account.1

The more interesting and nuanced story is that of The Narrow Bank.

The Narrow Bank is an elegantly simple concept. Rather than trusting your hard-earned money to FDIC insurance or a bank, what if you could store your money at the Fed?

Nothing in the law permits general access to the Fed, but The Narrow Bank created a workaround — it's just a passthrough that stores all customer deposits at the Fed. That's it.

As the name implies, The Narrow Bank is a Connecticut chartered bank, a depository institution. Unlike Fourth Corner Credit Union, there's nothing illegal about the bank's activities. But the Fed rejected the application anyway.2

George Selgin goes into considerable depth on why approving The Narrow Bank would be a bad policy decision, but that's neither here nor there. The bank was denied even though there's seemingly nothing in the law that should hinder its access to a Master Account. To add insult to injury, the Fed followed up by proposing new rules that would formally prevent any passthrough entity from eligibility.

While The Narrow Bank continues to try to find a path forward, another bank with an entirely different structure has found itself in a similar situation. Custodia (previously called Avanti), is a Wyoming chartered bank focused on supporting the cryptocurrency industry. The bank's charter was issued under a new Wyoming-specific structure, the Special Purpose Depository Institution.

Among its business plans, Custodia intends to issue a digital dollar backed by deposits and high-quality liquid assets. Well, what could be better than deposits stored in a Fed Master Account?

Twenty months — and counting — after applying for a Master Account, the Fed still hasn't approved or rejected Custodia's application. In June of this year, Custodia sued the Fed. The suit remains pending. There seems to be little more hope for Custodia than there was for The Narrow Bank.

Ambiguity and lack of transparency continue to be the problem. Without clear rules for eligibility and data on who has access, we're left in a world where the Federal Reserve gets to exercise seemingly arbitrary discretion divorced from the laws as written.

Even if a court were to rule that the Fed is operating within its congressionally granted discretion, the lack of clarity means that organizations like The Narrow Bank and Custodia are wasting millions of dollars simply because government organization hasn't documented its process. It's unnecessary waste.

It seems even the Fed has awakened to the situation. We may soon gain clarity, but not before more controversy.

Who Should Get a Fed Master Account?

The Federal Reserve has now issued two notices and requests for comments regarding Master Account eligibility. The first proposed six principles that the Fed would use in evaluating requests for accounts.

The most recent, published this past April, added an additional "three-tiered review framework to provide additional clarity regarding the review process for different types of institutions." Tier 1 is not controversial — it's the federally insured banks. Tier 2 and Tier 3 are the Fed's attempt to propose more strict levels of review for the many "nonmember bank[s] or trust compan[ies] or other depository institution[s]" who may be eligible.

The principles set a high standard for access including safety and soundness (#2), prevention of financial crimes (#5), and not adversely affecting the Fed's ability to implement monetary policy (#6). These are insurmountable obstacles for both unregulated fintechs and structures like The Narrow Bank in their current forms.

Bank Policy Institute believes that the principles don't go far enough. They advocate for a narrow definition of depository institution that would meaningfully restrict Fed Master Account access.

While the suggestions are made in the name of the "continued safety and integrity of the payment and financial system," it’s difficult to ignore the Institute’s clear conflicts of interest.

Bank Policy Institute is made up of one hundred or so invite only members including the largest US banks, insurance companies, and Visa and MasterCard. It’s an active lobbyist across a broad range of issues including accounting standards, Dodd-Frank, and capital adequacy. By virtue of a 2018 merger with The Clearing House, the group also operates multiple private payment systems that compete with those offered by the Fed. Greater availability of Fed services would increase competition.

This salvo is the latest in the Institute’s hold-the-line advocacy against new forms of banks and permitting competition from nonbanks.

As expected, fintechs and disgruntled applicants like Custodia are advocating for broader access. The camp is growing and now counts Thomas Hoeing among its members. As a former FDIC Vice-Chairman and former head of the Kansas Federal Reserve Bank, he's an unusually strong advocate to have on your side. His comments challenge the Bank Policy Institute's stance head-on (emphasis mine):

As important as these considerations are, the Fed should acknowledge that it cannot—and should not—attempt to eliminate all risk if innovative products and services are to be successfully introduced to the public. In fact, in seeking to eliminate all risk the Fed may ironically subject the public to greater risk than is necessary by frustrating beneficial innovation and competition.

[T]he Fed should be motivated by the original, underlying purpose of its involvement: providing the public with a higher-quality and more reliable payments system than could be provided solely by private industry. Although the validity of this purpose might be debated, at minimum the Fed should be motivated by the public interest, not any particular interest group or market incumbent.

A competitive economy must allow for firms to fail and be replaced with new firms that better meet customer needs. Even if the Fed believes that it cannot let certain firms fail, it should not limit access to its payments system on those grounds.

Therefore, the Fed should seek to adopt a bias in favor of access while maintaining appropriate safeguards.

It seems even members of Congress are intent on getting involved. The recently proposed and bipartisan Lummis-Gillibrand bill mostly concerns crypto, but includes in its text "that all depository institutions may access [Fed] services under the Federal Reserve Act." The expanded definition of depository institution includes banks like Custodia.

But let's come back to the core issues — eligibility ambiguity and lack of transparency on the process. The principles and tiered review framework don't fully address either. The Fed needs to go further. It's a point Professor Julie Hill nails in her draft paper:

The Federal Reserve should adopt procedures that detail how applicants can request accounts and services, what materials they must provide, and when they can expect the Federal Reserve to act on the request. The Federal Reserve should be clear about who is determining legal eligibility for the accounts and who is conducting the risk assessments. If the Federal Reserve Board’s assessment will be dispositive, the applicant bank should be allowed to make its case to the Board rather than rely on a district Reserve Bank as an intermediary. Determinations about which types of banks are legally eligible for Federal Reserve accounts, should be communicated to the public. This would encourage consistent decision making and prevent banks of the same type from needlessly traveling the same unfruitful path. Finally, the Federal Reserve Board should consider procedures that would encourage consistency across the Federal Reserve Bank districts.

I'd add one more suggestion — publish a regularly updated, publicly available list of who has a Fed Master Account.

The risks the Fed highlights in the principles are real. The way to test if the risks are realized or imagined is in public and with data. A public available list helps ensure that eligibility isn't static but continues to allow for innovation not even yet imagined.

Cocktail Talk

  • If you're looking to learn more about Fedwire, Master Accounts, and more, you need to read Professor Julie Anderson Hill's upcoming paper. She takes a broad view of the topics, going all the way back to the original services offered by the Fed member banks and how each bank differed in its interpretation of eligibility. (SSRN)

  • The Durbin Amendment is foundational for much of the current fintech revolution. Startup Ramp and Venture Capitalist Redpoint wrote a great overview of how it came to be and why it matters. (Ramp Blog)

  • I didn't fully appreciate the astonishing detail in the recently released image from the NASA James Webb Space Telescope under I watched this video. It's just 1 minute long and zooms into seemingly empty space to reveal an entire galaxy in extraordinary detail. It's a wonderful reminder of just how vast the universe is and how much more there is to discover. (YouTube)

  • Jimmy Fallon is a comedian, talk show host, and successful entrepreneur with a production company and multiple consumer products. His journey from small-town Hudson Valley New York to the heights of showbiz is as warming as it is educational. What particularly struck me is his drive. Beneath the endless giggles is a man with almost obsessive focus willing to put in the hard work to get where he wants to be. (How I Built This)

Your Weekly Cocktail

A complex daiquiri variant, but maybe not the right one for the weather.

Captain's Blood

2.0oz Aged Jamaican Rum
1.0oz Lime Juice
1.0oz Simple Syrup
0.25oz Velvet Falernum
2 dashes Angostura Bitters

Pour everything into a shaker. Add ice until it comes up over the liquid. Shake for ~20 seconds, until the outside of the shaker is frosted. Strain into a coupe glass and enjoy!

Captain’s Blood

Our daiquiri variations continue! This one's less adventurous than last week's but no less interesting. I used Smith & Cross as the rum, a navy strength pot still rum with wonderfully deep caramel flavors to complement the baking spice notes from the bitters and Velvet Falernum. The latter also helps amplify the lime so it can hold its own against such a strong rum. The result is a complex drink that starts off fresh and mouth-puckeringly like a traditional daiquiri but gives way to alcohol and then depth more reminiscent of a crust of a well-baked banana bread loaf. I like it, but it's not quite the right fit for the ridiculous heat wave we're experiencing. The drink's more of a cool night vibe than a thirst quencher.



Despite conditional approval, the credit union still doesn’t have a Master Account per Julie Hill’s correspondence with the firm. One of the conditions was that the credit union secure private share insurance, a pursuit which has been unsuccessful.


Well, sort of. The Fed refused to act on the application for 18 months until The Narrow Bank sued. The Fed then successfully filed for the suit to be dismissed. Since the Fed never rejected the application, no harm was done and the bank didn't have standing. The Fed technically still hasn't rejected the application, but it also hasn't approved it either. The Narrow Bank is left without a Master Account and without standing to sue. The score’s one-zero, Fed attorneys.

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