A report by the Federal Reserves on March 24 revealed the reason behind the denial of the Custodia bank membership application. The Fed shared an 84-page report demonstrating the unsuitability of Custodia bank’s management and current financial health.
The regulators argued that the Custodia team plans to engage in crypto-related activities, which would expose the investors to the risk of losses due to ongoing price fluctuation. Additionally, the regulators argued that Custodia’s business model and strategic plans relied on the performance of the crypto assets which are volatile.
Why did the Fed Reject Custodia Bank Membership Application?
The Worming-based financial provider applied to join the Federal reserve system in 2019 to provide crypto-related services in the US. The Custodia team aimed to address the challenges facing the US dollar transaction and the crypto assets payment services.
The application was submitted to the Federal Reserve Board’s review committee to evaluate whether the services offered by the Custodia bank fit the banking needs. After embroiled dialogue between the committee and the Custodia team, the application was denied on various grounds.
The regulators argued that the Custodia risk management tools failed to align with the organization’s goals. The committee observed that the Custodia risk management system lacked key features to monitor and assess risk necessary to comply with the Bank Secrecy Act (BSA) of 1970.
The bank’s risk analysis infrastructure was considered inadequate to oversee the deposits and withdrawal activities. Per the March 24 report, Custodia bank’s risk management system limited the operation of liquidity control activities and reporting of internal audits.
Also, the system lacked financial projection features and crucial information technology tools. The Fed argued that the Custodia bank risk management tool would fail to support the provision of crypto services in the long run.
In a previous report, the Custodia team had revealed plans to pursue new opportunities in the crypto world after the regulators approved their membership application. During the application, the financial institution mentioned the crypto assets, which will bring a high return on investment.
The regulators argued that the proposed crypto assets were in their early development stages which would lead to non-compliance. Moreover, the Fed argued that the Custodia team failed to reveal the strategies to be utilized in the provision of crypto assets that will uphold conformity with the Office of Foreign Assets Control (OFAC) regulations.
Scope of the Fed Report
After reviewing Custodia’s application, the regulators argued that the bank’s strategic plan demonstrated to be associated with the performance of the crypto market. They argued that the recent events in the crypto space and the bank’s proposal might expose the firm to financial instability.
Besides the provision of financial services, the bank demonstrated to have adequate resources necessary to remain operational. A Custodia pro forma report review revealed that the company has accumulated measurable capital from financial services.
The regulators remain pessimistic that the crypto services Custodia plans to offer will fail to meet the security and privacy standards. The Custodia bank proposal will create financial uncertainty since some crypto activities violate the national bank requirements.
The uncertainty in the crypto market and the ongoing banking crisis compelled the regulators to reject the Custodia membership application. They argued that the involvement of Custodia in crypto activities might undermine the actualization of the Federal Reserve Act of 1914.
Elsewhere, market critics argued that if the Fed decision favoured Custodia bank, the financial provider would be required to improve compliance and adopt practical security measures to attain the desired results.
