Global: Federal Reserve Establishes Framework for Banks’ Use of Stablecoins

The Federal Reserve’s issuance of a new supervisory letter outlining the process for state member banks employing dollar-backed tokens, like stablecoins, to facilitate transactions has sparked criticism from members of Congress on Monday (August 28, 2023).

Earlier this month, the Fed released guidelines mandating that state member banks obtain written supervisory nonobjection from the Federal Reserve before engaging in activities related to issuing, holding, or transacting with dollar tokens, according to an official press release from the agency.

The directive is designed to ensure that banks implement effective risk management practices, including systems to detect and monitor potential risks such as cybersecurity threats and illicit financial activities. State member banks involved in dollar token-related undertakings will also be subject to ongoing supervisory scrutiny and heightened monitoring.

Furthermore, the Federal Reserve established a Novel Activities Supervision Program aimed at overseeing “novel activities” conducted by banking entities. This encompasses crypto-assets, distributed ledger technology (DLT), and tech-driven collaborations with nonbank entities for delivering financial services. The program seeks to complement existing supervisory procedures and bolster the oversight of technology-driven operations.

In a released statement, the agency stated, “The goal of the novel activities supervision program is to foster the benefits of financial innovation while recognizing and appropriately addressing risks to ensure the safety and soundness of the banking system. The program will be integrated into the Federal Reserve’s existing supervisory processes, with program experts working alongside current supervisory teams to oversee banks engaged in novel activities.”

However, on Monday, legislators criticized both initiatives, arguing that the Federal Reserve was undermining congressional efforts to formulate stablecoin regulations.

In a letter addressed to Federal Reserve Chairman Jerome Powell, U.S. Representatives Patrick McHenry (R-N.C.), French Hill (R-Ark.), and Bill Huizenga (R-Mich.) expressed their concerns. McHenry chairs the House Financial Services Committee, Hill serves as the vice chair, and Huizenga is the chair of the Oversight and Investigations Subcommittee.

The letter stated, “We are concerned that these actions are being taken to subvert progress made by Congress to establish a payment stablecoin regulatory regime. Moreover, if these letters are left in place, they will undoubtedly deter financial institutions from participating in the digital asset ecosystem. Congress understands the need to provide regulatory certainty for payment stablecoins and the broader digital asset ecosystem. A regulatory framework established by Congress will better protect consumers and provide certainty to market participants.”

The issuance of these letters by the Fed follows the growing interest and involvement of banks in stablecoins and other cryptocurrency-related activities, following prominent collapses in both the banking and cryptocurrency sectors over the past year.

Meanwhile, the launch of a stablecoin by PayPal has triggered concerns among lawmakers. U.S. Representative Maxine Waters, the leading Democrat on the House Financial Services Committee, expressed profound reservations about PayPal’s decision to introduce a stablecoin. Waters highlighted the necessity of federal oversight and enforcement to ensure consumer protections and alleviate concerns about financial stability.

The divergent perspectives on stablecoins within the House Financial Services Committee reflect the ongoing debate regarding cryptocurrency regulation and the necessity for comprehensive oversight of digital assets. While some legislators view stablecoins as a promising element of the modern payments system, others emphasize the significance of clear regulations and robust consumer safeguards. The formulation of stablecoin regulations is pivotal in striking a balance between encouraging innovation and ensuring financial stability.