Federal Reserve Issues Guidance on Novel Activities, Including Bank-Fintech Partnerships

On August 8, 2023, the Board of Governors of the Federal Reserve System (FRB) issued two Supervision and Regulation Letters (“SR Letters”) that provide guidance on the agency’s supervision of novel activities and the process that state member banks should follow to engage in certain stablecoin/Dollar Token activities. 

Creation of Novel Activities Supervision Program. In SR Letter 23-7, the FRB announced the establishment of its new Novel Activities Supervision Program (“Program”). The Program’s focus will be on novel activities related to crypto-assets, distributed ledger technology, and bank-Fintech partnerships.[1] The FRB states that the Program will complement existing supervisory processes by partnering with existing supervisory teams to monitor and examine these novel activities. In addition, supervision under the Program will be “risk-based,” meaning that the level and intensity of supervision under the Program will vary based on the banking organization’s level of engagement in novel activities. The FRB notes that novel activities may involve unique questions about the ultimate permissibility of the activity, existing supervisory methods, and how the activities may impact the financial system.

Banking organizations whose novel activities will be subject to examination through the Program will be notified in writing.

Supervisory Nonobjection Process for State Member Banks Seeking to Engage in Certain Activities Involving Dollar Tokens. In SR Letter 23-8/CA 23-5, the FRB describes the supervisory nonobjection process for state member banks seeking to engage in certain activities involving tokens denominated in national currencies and issued using distributed ledger technology or similar technologies to facilitate payments (“Dollar Token Activities”).[2] Under SR Letter 23-8, prior to engaging in Dollar Token Activities (including testing activities), a state member bank must notify its lead supervisory point of contact about the bank’s intention and cannot engage in the activity until it receives a written notification of supervisory nonobjection.

To obtain a written supervisory nonobjection, a state member bank must demonstrate that it has appropriate risk management controls in place to conduct the activity in a safe and sound manner. When evaluating if a bank has the requisite risk management capabilities, the Federal Reserve will focus on operational risks, cybersecurity risks, liquidity risks, illicit financing risks and consumer compliance risks.[3] Federal Reserve staff also will assess whether the bank has demonstrated that it understands and will comply with laws that apply to the proposed activities.

A state member bank that was engaging in Dollar Token Activities prior to the release of SR Letter 23-8 may continue to engage in such activity but should notify its lead Federal Reserve supervisory contact of such pre-existing activities by September 8, 2023. The FRB will review the existing activity and provide the bank with a written response indicating whether a supervisory nonobjection for the existing activities and any planned expansion is granted.

Key Takeaways

These supervisory letters build on, and are generally consistent with the careful approach of, the existing issuances of federal banking agencies regarding banking organizations’ crypto-related activities, including stablecoin/Dollar Token Activities.

Perhaps the more notable aspect of the releases is the categorization of bank-Fintech partnerships as a “novel activity” subject to the FRB’s new supervisory program.  While bank-Fintech partnerships have been subject to closer scrutiny in recent years, categorizing these activities as “novel activities” and placing the supervision of these relationship under the purview of the new Program may signal a concern with these activities. However, an alternative takeaway is that including bank-Fintech partnerships in the Program is an acknowledgement by the FRB that these relationships present unique issues that “traditionally trained” supervisors are not well positioned to evaluate. Under this alternative interpretation, replacing “traditionally trained supervisors” with supervisors who have a greater understanding about the underlying technology and the bank-Fintech business model may represent a positive change for banks and Fintechs who currently do, or wish to, partner with each other.

[1] SR Letter 23-7 describes these partnerships as “complex and technology-driven partnerships where a non-bank serves as a provider of banking products and services to end customers, usually involving technologies like application programming interfaces (APIs) that provide automated access to the bank’s infrastructure.”

[2] According to the FRB, the term “stablecoin,” as used by the Office of the Comptroller of the Currency (OCC), and the FRB’s term “dollar token,” are synonymous for purposes of OCC Interpretive Letter 1174. For purposes of the SR Letter, any bank liabilities (including deposits) that meet the definition of dollar token are “dollar tokens.”

[3] These risks also were described in the FRB’s Policy Statement on Section 9(13) of the Federal Reserve Act. The Federal Reserve may, in its discretion, consider additional risks.