Is the OCC Dragging the Legacy Banking System Kicking and Screaming into the Crypto World?

On January 4, 2021, the US Office of the Comptroller of the Currency (OCC) published Interpretive Letter 1174, which clears the way for national banks and savings associations to perform "bank-permissible functions" with independent node verification networks (INVN) and stablecoins. This is a further clarification of the earlier Interpretive Letter 1170, in which the OCC gave national banks permission to custody cryptocurrencies and provide "permissible banking services" to crypto-native and crypto-adjacent businesses. Following this new interpretive letter, banks can now not only custody and provide payment-related services including cross-border payments, but can also serve as a node in an INVN and offer more advanced crypto-based services. Additionally, banks now have the authority to issue their own US dollar-backed stablecoins.

This is extraordinary regulatory progress and has the potential to reduce transaction costs and frictions. Consequently, banks can finally compete with FinTech companies, such as PayPal and Square, as well as CeFi and DeFi service providers. However, even though the distributed nature of cryptocurrencies provides more resiliency, providing crypto-banking services does bring challenges for compliance and risk management teams. Banks looking to take this opportunity to participate more directly in the crypto-economy will need to update their regulatory compliance, corporate governance, and risk models. This includes customer due diligence, transaction monitoring, as well as smart contract exploits and vulnerabilities. One of the criticisms surrounding the new regime is that this exposes the taxpayer to the wider range of risks posed by crypto networks. In the eyes of the critics, this means that the banks take on exposure to smart contract failures or exploits and potential degradation of the US dollar currency peg. Should such adverse events take place, it could pose a systemic risk to the banking sector, a black swan event of sorts, and may need to be rescued with taxpayer money.

More broadly, while the new changes may threaten the existing SWIFT (ACH and Fed Wire) system, they will also increase the United States' influence on US dollar pegged stablecoins. Giving banks the ability to use or issue stablecoins may be a signal to other central banks that the banking regulators want the emerging Central Bank Digital Currencies (CBDCs) to follow a wholesale distribution model. From a geopolitical prospective, this looks like a cleverly improvised way of positioning the U.S. banking sector and the U.S. dollar against the increasing number of CBDCs that have been mooted since 2020. By taking the lead in integrating stablecoins into the traditional banking system, we may see US dollar backed stablecoins become the primary global settlement tokens. Protecting the U.S. dollar's reserve status is increasingly important, as China has made considerable progress since the launch of the Chinese Yuan CBDC in 2020.

Hakob Stepanyan, a Senior Associate on FRA's Forensic Accounting team, is also a contributing author to this article.