Washington Watch: ‘Only the elites have the ability to have bank accounts all over the world’: Small businesses battle Fed for master account access.

In meetings with federal regulators, he had tried to convey that his new financial company would be safe and profitable. Just a few months earlier, the Federal Deposit Insurance Corp. had ruled that for his bank, as a nonlending payments bank promising to maintain full backing for all its deposits, no insurance would be required. Officials from the Federal Reserve Bank of San Francisco, nominally tasked with granting Danenberg’s request for a master account at the central bank, told him that based on his business plan, they would be in a position to approve the request once a state banking charter had been granted. 

Master accounts, which give banks and credit unions access to the Federal Reserve’s financial services to settle and clear global transactions, are at the center of trillions of dollars of daily money flows. Danenberg needed access in order for his business to function.  

But after the charter was conferred, the Fed fell silent. Nearly 10 months passed before it sent a one-page letter to Danenberg denying his request. It said that Danenberg’s “unproven” and “novel business model” presents undue risk to the U.S. central bank, and that the company’s focus on international trade leaves it open to “money laundering and terrorism financing risks.”

Danenberg, 33, said he was “disgusted” when he received the letter, having spent the better part of his adult life dreaming of building a company that could enable small businesses to access international markets without needing the goodwill of one of the handful of megabanks that now dominate cross-border trade settlement. 

“Today, the way business works, only the elites have the ability to have bank accounts all over the world to move money between continents,” Danenberg told MarketWatch. “We want to change that.” 

Danenberg isn’t the first entrepreneur to crash his ship on the rocky shores of the byzantine U.S. system of financial regulation, but he hopes to be one of the few to ever take the Federal Reserve to court and win.

His case, filed in federal court in Boise, is one of three filed this year challenging the Fed’s discretion to deny state-chartered banks access to the nation’s public financial infrastructure. The others are a Wyoming cryptocurrency-custody bank that was denied a charter and a Puerto Rican bank that had its charter revoked amid accusations of insufficient money-laundering controls.

The Fed has increasingly been blocking new banks engaged in innovative and unconventional activities from obtaining master accounts, much to the frustration of these businesses, which claim the central bank does not have the authority to stop them after they have obtained state banking charters. 

Danenberg remains confident that the law is on his side, but he worries that he has become “caught in a political battle” as politicians in Washington, D.C., spar over crypto policy and as a conservative push in the courts to rein in the power of financial regulators has motivated progressives to doggedly defend the status quo, even if that means reinforcing the power of the big banks and a wildly profitable incumbent financial sector.

An entry ticket to the global economy

Danenberg, who was born in Belgium, trained as an electrical engineer but prides himself on being a self-taught expert in software coding and financial regulation. After graduating in 2012, he met Belgian central banker and currency trader Bernard Lietaer, who became his mentor. Lietaer, who died in 2019, had worked on the implementation of the European Currency Unit, the precursor to the euro. 

One of Lietaer’s interests as an economist was how the global monetary system is a hindrance to prosperity in the developing world, and he advocated for the creation of parallel currency systems to work alongside official ones to stimulate economic activity in depressed areas. 

Danenberg learned from Lietaer about the slow, expensive and risky nature of cross-border payments and the importance of the U.S. dollar in an increasingly global economy that lacks a common means of settling transactions. 

“Where there is a problem, you have a business,” Danenberg said. This problem led him to come to the U.S. on an investor visa and to begin to build an application that he hopes will serve as a means for small and midsize enterprises to more easily trade across borders.

The PayServices app would leverage face- and voice-recognition technology and GPS data to identify and track its customers in order to comply with know-your-customer and anti-money-laundering regulations, enabling the bank to make sure that foreign account holders aren’t using the system to trade in illicit goods or otherwise launder money. 

Danenberg’s initial strategy for building out the business has involved recruiting foreign governments in places like Africa, South America and Asia. He recently traveled to Ivory Coast to meet with government officials, who were eager to learn how PayServices might enable small producers of commodities like coffee, cocoa beans and palm oil to connect with U.S. manufacturers of end products. 

“If I’m a small U.S. business who wants to import this stuff from Ivory Coast, there’s simply no way for me right now to send the money,” he said. 

The Reserve Trust Scandal

In 2017, another small financial startup, Reserve Trust, chartered in Colorado, was approved for a Fed master account by the Federal Reserve Bank of Kansas City, enabling the company to raise more than $30 million in venture financing. 

Its business model was similar to that of PayServices: Offering U.S. dollar payment services to international businesses that had lost access to U.S. banks after they shed customers with unappealing risk-return profiles in the wake of the financial crisis.

At first, the Fed denied Reserve Trust’s initial application, but it reversed course less than a year later, after Sarah Bloom Raskin, then a recent veteran of the Obama-era Federal Reserve and Treasury Department, joined Reserve Trust’s board.

The episode became national news in 2022 after President Joe Biden nominated Raskin to serve as the Fed’s vice chair for supervision. 

Republicans, led by Pat Toomey, who was then chair of the Senate Banking Committee, labeled the turn of events suspicious, demanding in confirmation hearings and in communications with the Fed to know whether Raskin had leaned on her former colleagues to get the master account approved.

Julie Hill, a scholar of financial regulation at the University of Alabama, said in an interview that the Reserve Trust episode illustrates the arbitrary nature of the approval process, one that she believes doesn’t follow the letter of the law.

The Kansas City Fed said that the reversal of its decision was the result of Colorado regulators “reinterpreting” state law, but Hill said this explanation is lacking.

Kenneth Bold, Colorado’s state banking commissioner, told Hill in a February 2022 letter that the Kansas City Fed “misrepresented” its interactions with the Colorado Division of Banking and that his agency doesn’t have the authority to “change, modify or reinterpret state laws.”

“None of it makes any sense,” said Hill. “Maybe there’s a good explanation, but Kansas City hasn’t offered it.” 

Toomey, who served in the Senate until earlier this year, agrees, telling MarketWatch in an interview that despite Congress’s oversight powers, he was unable to learn the truth of whether there was any corrupt influence over the approval process for the Reserve Trust master account.

“They stonewalled us on that,” he said. “Clearly it was unusual.”

The Federal Reserve Board and the regional banks of Kansas City and San Francisco declined to comment, as did Raskin.

Even as the Reserve Trust scandal was unfolding, the Fed was in the process of developing a public framework for evaluating applications for master-account access from a rising number of “novel” charter types, which it finally implemented in August 2022, a few months after Biden withdrew Raskin’s nomination to the Fed board.

The guidelines are what Hill calls a “monument to the Federal Reserve’s claimed discretion over accounts and payments services.” They outline a tiered system for evaluating Fed master-account requests.

“The guidelines clarify that the Federal Reserve intends to subject requesting banks without deposit insurance to the regulatory equivalent of a proctology exam,” Hill wrote in a recent paper on the topic. “Except that proctology exams do not last for years.”’

The Fed’s ‘unchecked’ powers

Toomey was convinced, in part by the Reserve Trust episode, that the current Federal Reserve system — made up of private regional Fed banks that are owned by member banks — is an “archaic structure” and a “relic from a previous era” in need of reform. 

One of his last acts as a lawmaker was to help shepherd a law through Congress that requires the Fed to publish a list of all the financial institutions with master accounts and those with pending applications, which it began doing in June. 

“This whole list would be a very good starting point for Congress to have a hearing and ask the Fed a lot of questions about why some of these companies are on the list and why some aren’t and what the criteria is,” Toomey said. 

For Danenberg, the publication of the list was further evidence that something was amiss. 

“When you see that the Bank of Egypt has an account, or the Bank of Pakistan, you realize the Fed has no accountability,” he said.  

The lack of oversight over the Fed’s decision making is a common feature of bank regulation more broadly, according to David Zaring, a law professor at the University of Pennsylvania.

“Banks labor under heavy, and in almost every important way, unchecked regulation,” he wrote in a June article in the Iowa Law Review. This situation, according to Zaring, challenges the “basic assumptions of American administrative law,” including the idea that transparency, regular judicial review and cost-benefit analyses all make for better regulations.

“The banking regulatory regime features none of these regulatory basics,” Zaring wrote. 

The Federal Reserve, which after the financial crisis of 2008 became the nation’s most important banking regulator — in addition to its role as the federal government’s fiscal agent and implementer of monetary policy — is to a large degree unburdened by oversight. 

Congress does not control the Fed’s budget, the White House does not vet Fed regulations like it does for other agencies, and the staggered 14-year terms of Fed governors and a tradition of central-bank independence mean even the president has limited influence.

What’s more, because regional Fed banks are private entities, federal courts have less power to check their decisions, and they are not subject to transparency laws like the Freedom of Information Act.

Zaring argues that the unique nature of bank regulation stems from the government’s interest in providing U.S. businesses with credit and from the ever-present danger that the banking system can go haywire as it did in 2008, “with consequences well beyond the investors and managers of a bank that fails.” 

The basic agreement, then, is that banks submit themselves to the imperial powers of the Federal Reserve and other regulators, and in return they get access to Fed infrastructure like risk-free accounts and payment rails — as well as the implicit promise that they will be bailed out if things really go haywire. 

This deal may be well and good for incumbent financial institutions, but the example of PayServices raises the question of who gets to decide which banks are dealt into this system of intense regulation and generous subsidies — and which banks are left out in the cold.

Operation choke point 2.0

The Reserve Trust episode only exacerbated concerns that many lawmakers had been expressing over the Fed’s failure to grant master accounts to novel banks, like Four Corners Bank, a Colorado institution that was started in order to serve the needs of cannabis businesses after the state legalized recreational use in 2012. 

National banks have long refused to serve cannabis businesses in states where the substance is legal to use, given that it remains illicit at the federal level, saying that banking services for those who traffic in marijuana would violate anti-money-laundering laws. 

It’s the cryptocurrency industry, however, that some believe is driving the Fed’s increasing reluctance to offer master accounts to state-chartered institutions. 

Caitlin Long, the founder and CEO of Custodia, a recently opened Wyoming depository institution that offers bitcoin
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and ether
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custody and dollar payment services, first applied for a Fed master account in 2020. The application was denied in January. 

Long told MarketWatch that, like Danenberg, she felt her company was making progress with the Fed in its application and that she was “blindsided” by the denial of the account. 

In its lawsuit against the Fed, Custodia describes the denial as a “coordinated maneuver orchestrated by the [Fed] Board in consultation with the White House,” in a political climate that had become increasingly anti-crypto following the failure of cryptocurrency exchange FTX.

Nic Carter, a general partner at the crypto-investment company Castle Island Adventures, believes that the federal government is broadly cracking down on the crypto industry through regulatory measures that he calls “Operation Choke Point 2.0,” referencing the Obama-era scandal over banking regulators’ moves against the payday-lending industry. 

“There’s a distinct policy at the federal level to marginalize the crypto space and limit its access to the financial system,” Carter told MarketWatch, adding that companies in the industry struggle to get access to basic banking services, a trend that has only worsened since the failure of two banks associated with the crypto industry earlier this year: Silvergate and Signature Bank of New York. 

The Biden administration’s turn against the crypto industry has been anything but subtle. As recently as last May, industry insiders were optimistic that a Biden executive order on digital assets that touted the “potential benefits of digital assets and their underlying technology” was a signal that the White House would take a balanced approach to crypto. 

But since that time, the Treasury Department has sanctioned Tornado Cash, a decentralized finance, or DeFi, protocol that enables users to obfuscate transactions on the Ethereum blockchain, and in April, it published an exhaustive report on the threats DeFi poses to efforts to combat money laundering and funding of illicit activities. 

In January, the Fed, in conjunction with the FDIC and the Office of the Comptroller of the Currency, issued a warning on the threat of crypto to the banking system, stating that they would be “carefully reviewing any proposals from banking organizations to engage in activities that involve crypto assets.” 

Meanwhile, Democrats in Congress appear to have abandoned bipartisan efforts to write crypto-specific financial regulations as the Securities and Exchange Commission has brought enforcement actions against the world’s two largest crypto exchanges: Binance and Coinbase
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Wyoming Sen. Cynthia Lummis, a Republican, told MarketWatch in a statement that Wyoming’s bank charter law fully complies with the Federal Reserve Act, and therefore it has no basis to deny Custodia a master account. 

“By repeatedly denying master accounts to institutions that custody crypto assets, the Federal Reserve is failing in its responsibility to ensure crypto assets are properly regulated and the risks are managed,” she said. “These decisions are more about politics than bank regulation.”

End game

Danenberg worries that PayServices has gotten caught in the crossfire in the battle over crypto policy, but also that federal regulators’ negative attitude toward crypto is illustrative of broader skepticism of financial innovation. 

“The Fed has kind of started to awaken to the fact that there is new stuff coming to market that makes the old model obsolete,” he said, adding that the incumbent banks that own shares in the regional Fed banks have little incentive to welcome new models for providing financial services. 

Other noncrypto-banking companies are also fighting the Fed in the courts, with the latest suit filed in July by the Puerto Rican bank whose master account was revoked by the Federal Reserve Bank of New York over concerns about compliance with U.S. sanctions and anti-money-laundering laws. 

Dozens more are waiting for their applications to be reviewed, with little information as to when or why they will be accepted or denied. 

Hill, the scholar at the University of Alabama, believes that the law is on the side of those banks fighting for a master account and that the Fed does not have the discretion to deny eligible banks access to accounts and payment services. 

At the very least, she said, the Fed must be more transparent about why it’s accepting some applications and denying others.

“Take the Custodia example,” she said. “We can guess that the Fed doesn’t want to do it because it’s crypto-related, but we don’t really know because they won’t say.”