Unprecedented Legal Battles Against the Fed: A Shift in US Banking Culture

Battles in the forms of industry complaints and lawsuits with regulatory agencies like the SEC and the Consumer Financial Protection Bureau (CFPB) are by now common in the financial sector.

But not with the Central Bank — i.e. the Fed!

Most of you won’t be surprised if I tell you that in the last 5yrs, a Puerto Rican bank has sued the Fed, joining crypto Custodia Bank and narrow bank TNB USA.

These small entities (not systemically significant) suing the Central Bank, may not be bad omens but now that 3 of the Top-tier US banks are considering suing the Fed, we must pay attention.

In July 2023, Banco San Juan Internacional (BSJI) went to court with a sanction-related complaint. The Fed was freezing its master account because of links with Venezuela (actual or potential).

Reuters reported: `The Fed’s New York branch informed the bank earlier this year that its “master account” — which lets banks access the Fed’s electronic payment systems — would be terminated due to concerns about its compliance with U.S. sanctions and anti-money laundering rules.`

2019-to date: Custodia Bank, the Fintech crypto narrow bank (no lending), has fought in court for access to a master account over the past 3–4yrs. The application process for direct access to the Federal Reserve’s payment systems and the ability to earn interest on reserves held at the Fed was extended over 18 months. It ended with a rejection in January 2023, partly due to Custodia’s crypto-friendly nature and its status as a state-chartered bank without federal deposit insurance.

Custodia continues its legal battle.

A less known case is the lawsuit from a new Connecticut-based narrow bank, in 2018 TNB USA Inc. formed by James McAndrews, the New York Fed’s former research director. They also sued the Federal Reserve Bank of New York alleging that it was unlawfully blocked from opening a master account. The claim was dismissed because no official denial had been given.

Even if you choose to ignore these idiosyncratic incidents, you can’t deny that there is a growing sentiment building up in the US complex regulatory environment of regulatory overreach.

The frustration with federal regulators has left the private corporate rooms where C-suite discusses with banking lobbyists, and is joining the Puerto Rican bank, Custodia, and TNB US. The reasons are different, but this is the first time that we see this type of business culture shift.

Headlines: Big banks mull the unthinkable: suing the Fed

The lawsuit that is being drafted as we speak aims to block proposed Fed rules that would significantly raise the capital requirements, especially for large players. Regulators say the proposal would result in a 16% increase in capital levels and a 20% increase in risk-weighted assets for big banks.

Big Banks are specifically arguing against the proposed increased risk weights for loans to large government pension funds and in general the impact on their lending activities.

The lawsuit is being drafted on behalf of the Bank Policy Institute, a trade group that represents JPMorgan, Citibank, Goldman Sachs, and others. The Wall Street on Parade reports that Jamie Dimon has hired Eugene Scalia, the son of the former Supreme Court justice and a well-known conservative litigator. Scalia is expected to argue — if the case does go to court — that the banking regulators did not do a proper cost-benefit analysis before proposing these stringent capital rules.

While this boxing show is going on, the SME funding gap persists and the too Big to Fail banks are growing. If banks shouldn’t provide credit, then shadow banking will explode.

The Fed has clearly not been transparent with its screening for access to Master accounts and with other decisions during challenging times.

Will we see more lawsuits against the Fed like the one post-GFC (Great Financial Crisis) by Bloomberg?

In Aug. 2009, the Federal Reserve lost in court a case brought against them by Bloomberg. The Fed had refused to provide information to Bloomberg about the expansion of their lending programs in 2007–2008 and the sale of Bear Stearns to JPMorgan.

The Fed, despite its 110 years of existence, is facing a growing credibility problem. The whispers around the water cooler suggest that the Fed’s delayed recognition of inflation, which was not transitory as initially characterized, has led to severe consequences for banks.

The Fed’s response to inflation was indeed delayed, and this has had significant and broad repercussions.

The outrage among bankers is real, and it looks to me that some are choosing to voice their concerns in a non-diplomatic manner.

What are your thoughts on the increasing legal challenges against the Fed?

Do you see this as a sign of a shift in the US banking culture?

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