Custodia failed to wet the Fed’s beak.

In the movie “The Godfather, Part II”, Don Fanucci takes issue with a young Vito Corleone’s failure to share some of the items Vito and his gang have been stealing. Fanucci expresses that he does not want much, just enough to “wet his beak.” Corleone not only believes that the price Fanucci is asking for is too much but that Fanucci will amp up the level of extortion into the future. Fanucci soon meets his demise at the hand of Corleone in part due to greed and also to a feeling of invincibility, that no one in the neighborhood would dare touch The Black Hand.

I don’t think Custodia Bank thought of itself as invincible, but I do believe it failed to wet the beak of the Board of Governors of the Federal Reserve System when it applied for access to the Fed’s master account system. Access to the Board’s master account system would have granted Custodia access to the Fed’s discount window where Custodia could borrow emergency funds.

Membership in the federal reserve system also meant the ability to enter into transactions with other bank members of the Federal Reserve for the purpose of buying and selling excess reserves. These overnight transactions are entered when one bank does not have sufficient reserves for meeting the Board’s reserve requirements or where a bank does not have enough funds to settle the demands of depositors.

My reading of the Board’s order denying Custodia Bank’s application for membership leads me to conclude that the Board did not like the idea of Custodia using a Fed master account to indirectly backstop transactions for crypto assets conducted by Custodia’s depositors. While the Board addressed anti-money laundering, risk management, and financial management issues, I believe its biggest concern was Custodia looking less like a bank (it planned to offer very limited depositor services) and more like an exchange or broker, using the master account as a “compliant bridge” between crypto-asset transactions and the US dollar system.

The big failure on the part of Custodia was the narrative failure. The Federal Reserve System plays a prime role in validating the US dollar. It wholesales the US currency to its member commercial banks while the commercial banks retail the US dollar. As the dollar faces potential threats from current and yet to be developed resource-backed currencies, the last thing the Board wants is a bank primarily focused on crypto-asset transactions using the Fed to fund a rogue parallel payment system.

Custodia’s application should have interwoven the currency validation narrative into its sales pitch to the Fed. It would still have had to address the illicit activities/AML issues, but the Board’s ears may have stayed open a little while longer, giving Custodia time to finagle the right language or work out some compromise.

Custodia. Wet my beak.

Alton Drew

28 March 2023

Disclaimer: The data and output from this blog post does not constitute investment or legal advice and is not a personal recommendation from Alton Drew.  Nothing contained herein constitutes the solicitation of the purchase or sale of any futures or options.  Any investment activities undertaken will be at the sole risk of the reader.  Alton Drew expressly disclaims all liability for the use or interpretation (whether by visitor or by others) of information contained herein. Decisions based on this information are the sole responsibility of the reader.  Any visitor to this page agrees to hold Alton Drew harmless against any claims for damages arising from any decisions that the visitor makes based on such information.

This page contains affiliate links.  If you choose to make a purchase after clicking a link, I may receive a commission at no additional cost to you.  Thank you for your support.