The Fed Shuts Down Bank over Failure to Obtain Approval for Stablecoin Venture
In a banking environment that sees ever increasing competition among financial institutions, middleware companies, and fintechs, the push to “innovate” and get to market “yesterday” can be hard to resist. To this end, fintechs, and often the middleware companies they partner with, spend a lot of time “working” their bank partners, pushing them to approve and support new, innovative, and sometimes untested financial products and services, and to do so on timeframes that are often accelerated to a point beyond the capabilities of the bank to effectively manage.
While the pressures on financial institutions to support new services and move at the speed of light can be difficult to resist, a recent enforcement action from the Board of Governors of the Federal Reserve System (the “Federal Reserve”) underscores the very real and significant risks to banks from moving forward in the name of innovation before fully vetting the opportunity and the banks’ due diligence obligations.
In an enforcement action released on August 17, 2023, the Federal Reserve announced the shutdown of Farmington State Bank (“FSB,” based in the state of Washington) over its failure to obtain the Federal Reserve’s prior approval for a change in FSB’s business plan.
In particular, FSB had made prior commitments to the Federal Reserve that FSB would not change FSB’s business plan, including engaging in servicing activities with respect to digital bank operations. Subsequently, FSB, without the Federal Reserve’s knowledge or approval, engaged in activities that changed FSB’s business plan by entering into a non-binding memorandum of understanding with a third-party fintech, whereby FSB committed to work with the fintech to facilitate its issuance of stablecoins to the public. FSB then took what the Federal Reserve described as “material steps” to implement the memorandum of understanding. These facts were uncovered in a Federal Reserve examination of FSB and, shortly thereafter, FSB announced it would end its digital asset activities and voluntarily cease operations and liquidate.
The case of FSB is a warning to financial institutions from moving forward with activities in support of fintechs, and digital assets in particular, before the bank has fully vetted what such an action requires vis-à-vis its regulators. This is true even at the most preliminary of stages, such as entering into a non-binding memorandum of understanding. At a minimum, banks must understand what commitments they have made to their regulators for sharing and obtaining prior approval for future activities that may change the bank’s business plan and general character. These commitments may necessitate moving at a more deliberate and cautious pace than the fintech partner is accustomed to, but where the alternative is an enforcement action from the bank’s prudential regulator, it is still incumbent upon the bank to be the bearer of bad news.
The Federal Reserve’s press release and enforcement action regarding FSB can be found here: https://www.federalreserve.gov/newsevents/pressreleases/enforcement20230817a.htm