The Future of Payments

Should Non-Bank Payment Firms Be Eligible to Open Federal Reserve Bank Accounts? 92 BANKING PERSPECTIVES QUARTER 4 2018 vary considerably in scope and depth, as well as in the substantive regulatory requirements (e.g., minimum capital standards) applied to regulated institutions. This is not to say that an institution without federal prudential supervision could never open a master account under current policy. But, given its dependence on prudential supervision to manage participant-based payment system risks, the Federal Reserve limits approval of such accounts to situations in which circumstances mitigate risk in other ways. Such mitigating circumstances do not exist for typical non-bank payment firms. OPTIONS FOR DIRECT ACCESS Direct access to master accounts by non-bank payment firms would therefore require changes to the Federal Reserve’s approach to managing participant-based risk in Federal Reserve-run payment systems. These changes could take various forms. One option is to limit the expanded access to certain types of regulated non-banks and rely on the existing applicable non-bank regulatory regimes to provide the necessary information and assurance regarding financial and operational soundness. This option would require the Federal Reserve to evaluate the relative worth and weight of different non-bank financial regulatory regimes and regulators and determine how to fit them into a single risk management framework. In the past, such apples-to- oranges comparisons have proven difficult and tended to leave all stakeholders dissatisfied with the outcome. The effort would be particularly challenging when it comes to state-based regimes, given the considerable variability in the approaches and resources of different state financial regulators. One can hardly expect the Federal Reserve to discriminate among similar institutions in different states based on its judgment of the relative rigor of supervision in one state versus the another. The approach also risks competitive unfairness to conventional depository institutions, whose applicable regulatory and supervisory regime would likely remain more rigorous than that for other institutions. On the other hand, making the non-bank regimes more “bank-like” would impose unnecessary burdens on the great majority of non-banks with no interest in master accounts. A second option is to authorize the Federal Reserve to create and administer a new supervisory and regulatory regime for non-bank firms with master accounts. The applicable Federal Reserve Banks could use the supervisory resources based at their respective banks to examine the non-bank payment firms as prudential regulators. While the Federal Reserve can already impose account approval conditions, some of which can have de facto regulatory effects, the full scope of authority and resources needed for effective regulation would likely require legislative action. The Bank of England employs a combination of the two options, relying on non-banks’ existing regulators while imposing a strengthened supervisory regime and tailored operational arrangements beyond those applicable to ordinary non-bank firms. This is also, in a sense, the path originally followed by the Federal Reserve when it established supervision of its member banks in parallel with supervision by their chartering regulators. That said, the second option suffers some of the same drawbacks as the first. The need to “adapt” the prudential bank regulatory regime to a non- bank financial institution evokes the complexity and controversy that attended supervision of systemically important non-bank firms under the Dodd-Frank Act. Moreover, making such an adapted regime sustainable for a non-bank payment firm may still require regulators to place traditional banks at a competitive disadvantage. THE BANK CHARTER ALTERNATIVE The second option for facilitating direct access by non- banks also has a more fundamental drawback: In a sense, it reinvents the wheel. The option posits a non-bank firm prepared to be regulated as a bank, and then proceeds to propose the creation of a new “bank-like” supervisory and regulatory regime to satisfy this requirement. Rather than creating yet another U.S. financial regulatory system, it seems more logical to examine the obstacles preventing the firm from actually becoming a bank.