This Bank Was Denied Membership Into the Federal Reserve System. Here's Why

Not every bank can become a member of the Federal Reserve System.

In January, Custodia Bank, Inc. of Cheyenne, Wyoming, was denied membership to the Federal Reserve System. Here, we examine why Custodia Bank's application was rejected and why it matters.

Why the denial?

In rejecting Custodia Bank's application to become a member of the Federal Reserve System, the Federal Reserve Board wrote the following: "The firm proposed to engage in novel and untested crypto activities that include issuing a crypto asset on open, public and/or decentralized networks."

The Board went on to say that Custodia Bank's business model and proposed focus on crypto assets presents significant safety risks.

The Federal Reserve Board has made no secret of its issues with cryptocurrency activities, but its rejection of Custodia Bank runs deeper. According to the Board, Custodia's risk management framework is insufficient to handle the greater risks associated with its proposed crypto activities. For example, it lacks the ability to control money laundering and terrorism financing risks.

Why does it matter?

The Federal Reserve is the central bank of the United States, created in 1913 to provide a safer, more stable financial system. In addition to maintaining financial stability, the Fed is charged with overseeing financial institutions to ensure they are sound and to protect the rights of American consumers.

And here's why it matters when a bank's application is rejected: Gaining membership to the Federal Reserve System is the ultimate endorsement of a financial institution. The Fed is choosy about which banks become part of its system, and not making the cut is enough to make consumers wonder why.

The Fed's biggest priority is to protect consumers. If it sees anything "hinky" about the way a bank is organized or does business, it does not allow membership.

Currently, more than one-third of U.S. commercial banks are members. National banks are required to be members, while state chartered banks must meet certain requirements to be accepted.

When a member bank gets into trouble, it has the backing and protection of the Federal Reserve System to keep it stable.

Not all banks want to join

State chartered banks are not required to apply for Federal Reserve System membership, and some choose not to. The fact is, there are easier ways to go about doing business. Federal Reserve banks are held to stricter, more onerous standards than banks following state laws, and not all banks want to adhere to a tighter set of regulations.

However, for a consumer looking for assurance that their bank has the Fed's seal of approval, membership in the Federal Reserve System is a must.

Custodia is not giving up

Despite the rejection, Custodia Bank released a tweet the same day the Fed's decision became public. It read, in part, "The Fed advised Custodia 72 hours ago that it could either withdraw its membership application or see it denied, and the Fed denied it in record time. Custodia offered a safe, federally-regulated, solvent alternative to the reckless speculators and grifters of crypto that penetrated the U.S. banking system, with disastrous results for some banks."

Custodia went on to say that it will continue to investigate the matter.