Home Policy & Governance Fed establishes ‘novel activities supervision programme’

Fed establishes ‘novel activities supervision programme’

Digital money: regulators are battling to keep up with technology-propelled innovation | Credit: Jonathan Borba; Pexels

The Federal Reserve is creating a ‘novel activities supervision programme’ to focus on banks’ activity in technology-propelled emerging fields such as distributed-ledger technology (DLT) and the fast-moving arena of cryptoassets.

The Federal Reserve Board – the US central banking system’s main governing body – this week (8 August) described the new programme’s overarching goal as being ‘to foster the benefits of financial innovation while recognising and appropriately addressing risks to ensure the safety and soundness of the banking system.’

Supervised entities engaging in ‘novel activities’ will not be re-assigned to a separate supervisory portfolio. Instead, the programme will be integrated into the Fed’s existing supervisory processes, with programme experts ‘working alongside current supervisory teams to oversee banks engaged in novel activities’.

Activities that will fall under the new supervision programme include ‘complex, technology-driven partnerships with non-banks to provide banking services to customers’, as well as ‘activities that involve cryptoassets and distributed-ledger or “blockchain” technology’.

The Fed Board also this week issue an update on the process that a state bank supervised by the Fed needs to follow ‘before engaging in certain dollar token or stablecoin activity, including demonstrating to its Federal Reserve supervisors that it has appropriate safeguards to conduct the activity safely and soundly.’

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Seeking to ‘create greater clarity’

The Fed described its twin-announcements as part of its ‘ongoing work to create greater clarity for all parties as financial services and related technologies continue to evolve’.

It also said they build on a policy statement, issued more than six months ago, ‘to promote a level playing-field for all banks with a federal supervisor, regardless of deposit insurance status’.

The Fed’s 27 January statement sought to make clear that uninsured and insured banks supervised by the Board would be subject to the same limitations on activities, including crypto-related activities; and that uninsured and insured banks supervised by the Board would be subject to the limitations on certain activities imposed on national banks, which are overseen by the Office of the Comptroller of the Currency (OCC). The equal treatment would, it stated, ‘promote a level playing-field and limit regulatory arbitrage’.

In addition, the statement emphasised that banks must both ensure that activities they engage in are legal and conduct their business in a ‘safe and sound manner’. For instance, it stated that a bank should have risk management processes, internal controls and information systems that are ‘appropriate and adequate for the nature, scope and risks of its activities’.

The Board had, it stated, received ‘a number of inquiries, notifications and proposals from banks regarding potential engagement in novel and unprecedented activities, including those involving crypto’. The statement specified how it will evaluate them.

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Financial innovation’s pros and cons

The Fed’s long-serving supervision and regulation division director, Michael Gibson, has written to officers in charge of supervision and appropriate supervisory and examination staff at each Federal Reserve bank. He states that the novel activities supervision programme ‘applies to all banking organisations supervised by the Federal Reserve, including those with $10 billion [about £7.8bn] or less in consolidated assets’.

‘Financial innovation supported by new technologies can benefit the US economy and US consumers by spurring competition, reducing costs, creating products that better meet customer needs, and extending the reach of financial services and products to those typically underserved,’ Washington DC-based Gibson states in the 8 August letter. But he warns that innovation ‘can also lead to rapid change in individual banks or in the financial system and generate novel manifestations of risks that can materially impact the safety and soundness of banking organisations’.

Activities to fall under the new programme include projects that use DLT ‘with the potential for significant impact on the financial system’. Gibson’s letter mentions the exploration or use of DLT for use-cases such as issuance of ‘dollar tokens’ and tokenisation of securities or other assets. In terms of crypto, reference is made to crypto-asset custody, ‘crypto-collateralised lending’, facilitating cryptoasset trading and engaging in stablecoin/ ‘dollar token’ issuance or distribution.  

The letter states that the programme ‘will engage broadly with external experts from academia and the banking, finance and technology industries’ in order to ‘stay abreast of emerging issues, technologies and new products’.

US-headquartered PayPal made headlines earlier this week with its launch of a US dollar-denominated stablecoin called PayPal USD. In a separate move, London-based fintech company Revolut suspended its US crypto-currency services in the US last week, citing regulatory uncertainty.