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We obviously know the
importance of the Federal Reserve as well as the connections that
it has to the financial system.
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But now the Fed is considering allowing
access to part of its payment services to
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nontraditional financial firms across a
limited basis. Pleasure to be joined once again by
Wharton's David Zaring.
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David, great to talk to you again. How are you, sir? It's a pleasure to be here and I'm doing
well.
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Thank you.
All right. So this is called a— kind of a skinny
system. Can you explain what this is and why the
Fed is looking at this as an option?
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And I guess part of this
is kind of how the financial system has kind of evolved
in the last couple of decades.
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Yes. And indeed, this thing goes back over a
century. The Fed has created payment systems for
banks so they can send money to each other.
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And, you know, they used
to literally do this on the railroad, so they've become
known as payment rails.
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But basically that means that
if you're a Fed member bank or a state-run bank, you get
access to a master account.
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And that means you can
use the Fed's payment rails, and you get some
other things as well.
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Access to the discount window,
settlement services from the Fed, some interests paid on reserves that you
leave at the Fed.
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And that's all thought to be a valuable
way that banks can take advantage of the
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Fed services and move money around to each
other. And the big development here
is this idea that maybe some
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non-bank should have some
sort of access to the payment rails. Maybe not access to the discount window,
maybe not interest on reserves.
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But the ability to send money safely and
instantly to anyone. And that's what the skinny
charter is about, making
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non-banks eligible to use
the Fed's payment rails. And the examples of those types of banks
would be fintechs, etc.
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That's right. That's right. The first firm to get access to this sort
of skinny master account that we're still
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trying to figure out exactly what happened
is Kraken, which is a crypto brokerage.
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And those are the kinds of
firms that have expressed real interest in getting
access to the payment rails.
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But obviously, this is part of this growth
of how cryptocurrency has evolved and
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become part of the financial system in
general. And— so that they can have similar access
to what traditional banks have, correct?
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That's right. This would be something of— and maybe the
Fed should worry about this a little bit—
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it's something of an endorsement of
what these guys are doing. They're entitled to use the payment rails
just like member banks.
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That's sort of the Fed saying,
"We can do business with these people. They're the kind of
institutions that ought to
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be able to take access
of our financial services. And in that sense, they should be able to
do things that banks are able to do."
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So it's sort of an endorsement of these
fintechs. And— and in a good way, the good thing about
this endorsement is by accessing the
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payment rails, they create some
competitors for banks. The PayPal's of the world and other banks,
other fintechs that want to send money
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around, can do so without
hiring a correspondent bank to access the Fed's
payment rails for them.
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But it sounds like that some of the
traditional institutions may have some concerns about how this is being laid out
and maybe how it will all move forward
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with some of these non-traditional
entities. Yeah. The traditional banks, you know,
always worried about competition.
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But, you know, in their defense,
they think that they have to comply with a whole passel of extremely burdensome
regulations, including know-your-customer
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regulations, anti-money laundering
regulations. And, you know, they've expressed some
concern that these extremely lightly-
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regulated fintechs, they're
not regulated by the Fed or the other banking regulators unless
they purchase a subsidiary bank.
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These firms are sort of able to take
advantage of Fed services without complying with everything that they ought
to be complying with.
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And so that's been a concern for them. And it sounds like that some of the
entities that may have some concerns, or at
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least worried about
how this will impact kind of the overall system,
is the community banks.
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And the community bank
system, we know how important it is to the
strength of the U.S.
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economy. Do they have some valid concerns about how
if it isn't necessarily impacting the
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system as a whole, it
could potentially impact them and the business that
they do on a daily basis?
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Yeah. The community
banks, I think, are worried that they... it's tough to be a
community bank these days.
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They don't have the scale advantages that
the largest banks have. But one thing that they definitely do have
is an ability to do small and mid-sized
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business lending. They do the old school sort
of, "We take our deposits, we
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go lend them out, we go lend
them out to local businesses. And that's our franchise."
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And we want to be sort of do-everything
for these local businesses. So we'll handle your payments,
we'll help you raise money to a limited
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degree, and we'll lend
to you and open up accounts for your
employees, that kind of thing.
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That's what the hope is. And the concern is, well, then all of a
sudden they're not a do-everything for
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these small and medium enterprises, if
they're making payments with stable coins
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or making payments through some sort of
crypto firm. And that's a risk, that they'll
disintermediate these providers of small
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and medium business lending
that's probably pretty important for employment and the
overall health of the economy.
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How, then, does the regulation component
play into this, especially if you're
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talking about institutions that aren't
regulated in the traditional manner? And I ask that because we still have, in
some instances in and around
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cryptocurrency, the overtone
of concern of criminal activity that is kind of floated out
there every once in a while.
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That's right. Crypto is a really great way to do tax
evasion. And you worry about that kind of thing.
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The latest efforts by the federal
government's financial regulators is to basically get these
firms to take anti-money
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laundering and know- your-
customer compliance seriously. And one thing that firms that have been
interested in getting these charters have
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been doing is they've been hiring away the
anti-money laundering compliance officers
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from regular banks. They want to sort of set up a situation
where they can go to the Fed or whoever
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they're regulated with and say,
"Look, we didn't used to think about a KYC,
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but now we don't just think about it,
but we've essentially imported a bank's
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KYC unit into our unit. And so now we know who we're doing business
with and know that they're not bad guys."
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And so that's one of the sort
of pitches that they're making to the bank regulators for
access to a master account.
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So that's the story about how they're
trying to show money laundering expertise,
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is, often they're sort of buying it from
already regulated banks. And then, you know, the
community banks lose a
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compliance officer and
the fintech firms get one. So. Is it expected that this
was kind of a natural course of
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what was going to have to
happen with the financial sector because you've had this influx of
technology and all these different
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components that have been added in in the
last couple of decades that— allowing this
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so-called skinny master was going to have
to be part of the process at some point?
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Here I'll move a little bit into
advocacy. I think so. I really support the skinny master
account.
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It seems to make total sense to me,
too, with the internet, which is, of course, nationwide. With all these
fintechs that are doing business across
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state lines. To have to rely on
correspondent banks or money transmitter licenses, which are issued at the state
level
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and so, you know, you might have to get 54
of them if you include Guam and Puerto
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Rico, if you want to send money all around
the United States and its territories or whatever.
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And that's just really quite burdensome
for banks. And so, you know,
they've been looking into
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ways to get access to
the Fed's payment system. One way is with this sort of skinny master
payments chart.
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Another thing that fintechs have been
doing is buying up trust companies, which aren't really banks
in that they don't go
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making loans, but they're
regulated by bank regulators. And they're a way for you to keep money on
account at your crypto firm.
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And then they've said, "Look, we've got a
trust bank that's regulated, but
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federally. How about access to payment—
the payment rails now?" And so that's another way that they're
doing it.
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And I think it's a good idea to get these
people access to the payment rails.
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I'll note that, you know, state bank
regulators disagree with me on this. They think that they had some insight into
what these crypto and fintech firms were
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doing through their money transmitter
license oversight. And they think that the oversight and
capital requirements required of these
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fintechs is not nearly high enough, especially compared
to what they go through.
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And so they disagree with me about this
idea about the master account. So then could we be at
a point right now where
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there is still some
negotiation that will go on? There's talk of litigation coming down the
pike. That maybe what the structure of this
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is moving forward is still yet to be fully
finalized? Yeah, I think we may see some litigation.
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We may even see some litigation over
Kraken's master account access. That came as a surprise to some people.
Been some statements about it in the press.
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And so that may give the courts an
opportunity to weigh in on, you know, whether the Fed's exercising its
discretion in an adequate way here.
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And, you know, you don't
often see that. There's not always a ton of litigation over
what the Fed's powers are.
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And so that'd be pretty interesting
litigation I would want to pay attention to.
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It's also possible that Congress could come
in and try to settle this with legislation.
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They've been working on something called
the Clarity Act, which might sort of
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create some rules of the road for crypto
firms to access the banking system. And, you know, depending on the guardrails
they set up there, maybe everybody leaves
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the Clarity Act negotiations happy or
happy enough so that banks feel like they've got the protections that they need
and that crypto firms and fintechs have
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the access to the bank's payment
opportunities that they're seeking. Alright, David, thanks very much for your
time and shedding a little light on this.
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All the best. Happy to do it. It's always a pleasure. Thank you. David Zaring, finance professor here at
the Wharton School.