Paul Nelson, JD, LLM
It’s not an earthquake, but the tectonic plates under banking moved a bit recently. Because this movement involves cryptocurrency, maybe the plate that moved was “tech-tonic.”
Banking is not an area where things move fast. ATMs have been possible for more than 50 years, in actual use for perhaps 40, but universally used for only 10 years or so. Significantly for this article, the ATM has been responsible for banks’ reducing their reliance on brick-and-mortar branches.
A Digression on New Charters
The tectonic change now underway involves the bank charter itself. Bank regulatory junkies (they exist) will tell you that chartering of new banks follows a discoverable pattern. New charters often emerge after there has been a period of consolidation in banking. That consolidation often has a recession as its cause and the recession often has real estate at its center. When real estate fails, banks are weakened and when banks weaken mergers and acquisitions result. The consolidation has reduced the number of FDIC insured banks from about 14,000 in 1975 to 8,300 in 2000 to around 4,500 today. Branches have had a similar and related decline.
Despite the consolidation, there is usually a small contrary movement of new charters after each down cycle. These new charters are usually organized to take the place of a recently departed community bank, or mid-sized regional bank. This pattern of organizing new banks was apparently broken after the 2008-2009 recession. Bank regulators, Federal and State, allowed only one new charter until 2020. That bank, Bank of Bird-in-Hand, organized in 2013. It is exceptional, because its organizers found the way to serve the notably bank-resistant Amish population of Central Pennsylvania.
The New Charters of 2021
Now, in 2021 three new national charters have appeared. Two are state trust companies that converted to national charters. The latest, Paxos National Trust, has secured conditional approval from the Comptroller of the Currency as a de novo national trust company. Paxos exists within the cryptocurrency spectrum as a stablecoin, designed to reduce the price volatility that plagues Bitcoin, for instance. As an existing blockchain platform, the trust company is an extension of Paxos’s current business.
Conditional approval means that the company will almost certainly be allowed to open if it satisfies certain conditions. For most new banks a difficult condition can be capital but, according to reports on the charter, Paxos investors have raised $235 million, far more than the $10 million usually required to open a national bank or trust company. For Paxos the more difficult condition may be obtaining membership in the Federal Reserve. The Fed has not been wholly welcoming to new entrants to the payments system.
The Services the New Bank Will Provide
Paxos will not be a traditional bank, as it will provide few of the services associated with a traditional bank. It will not have FDIC insurance, as is customary for a charter involving only trust powers. The Paxos organizers have agreed not to engage in any activity that would qualify it as a bank under the Bank Holding Company Act. That means no loans (commercial or personal) and no demand deposits or transaction accounts. Instead, Paxos will provide a variety of services allowed for trust companies and trust departments of banks. The principal activity may be custody and management of crypto currency assets. Paxos also will perform trading services – purchase and sale of crypto assets – and agent services – payment and exchange. Paxos apparently also intends to provide Know Your Customer services for its clients.
By chartering Paxos as a trust company the organizers have avoided much of the risk the bank regulators face in chartering a traditional national bank. The capital calculation is arbitrary as it will not be related to the volume and quality of the company’s assets. Instead, capital is set at an amount the OCC believes will protect customers and the banking system. Without deposits or a loan portfolio, liquidity risk will be reduced. As long as its investment portfolio does not include cryptocurrency the company should not have more than the ordinary sensitivity to market risk as expressed through interest rate changes.
The Path Ahead
The conditional approval is a further step in the legitimation of crypto currency as a medium of exchange. There are challenges and Fed approval is the most significant. Another, almost as important, is litigation to block the OCC from chartering fintechs. The definition of a fintech is not yet precise and it’s possible that Paxos National Trust could fall within the definition, if the plaintiffs win
About the Author
Paul Nelson has over 45 years of involvement with the regulatory and legal compliance issues facing banks and nonbank financial services providers. His five years as a Senior Attorney and Acting Regional Counsel with the Comptroller of the Currency formed the basis of his education in the principles of bank regulation as practiced in the U.S. He has served as a General Counsel of the US House Banking Committee and as a lawyer in private practice. He has several years of experience with prominent consulting firms — PricewaterhouseCoopers, Promontory Financial Group and two smaller consulting firms.