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> Alternatives that remove or prohibit the leverage would be great. Fun fact, the Fed just denied chartering a new crypto focused bank, Custodia, that was plan

> Alternatives that remove or prohibit the leverage would be great. Fun fact, the Fed just denied chartering a new crypto focused bank, Custodia, that was planning to keep not just 100%, but 108% of customer cash on hand, thereby foregoing insurance, and make money from fees instead of lending customer money like a typical bank. > The Fed’s eviscerating explanation for its denial of Custodia cites the crypto bank’s decision not to insure its deposits – instead, the bank proposed to be fully capitalized, holding $1.08 in cash for every dollar deposited by customers – which the FRB said could increase Custodia’s risk of runs and contagion. https://www.coindesk.com/policy/2023/03/24/federal-reserve-says-custodias-crypto-focused-business-model-is-inconsistent-with-approval/ https://www.coindesk.com/policy/2023/03/24/federal-reserve-s... I suspect they aren't talking about runs and contagions on Custodia, but runs and contagions on all other banks if Custodia were allowed to exist. You can't have one bank totally safe from bank runs in an environment where every other bank keeps less than 10% of your cash on reserve. This breaks the system. Either everyone has to be fractional reserve, or no one can be.

IAmGraydon 4y ago
Fractional reserve allows banks to return some of their gains to the customer via interest. Does Custodia do that? If not, it's clear that they can both exist in the same market as they both offer different levels of risk and return. If Custodia were to pay interest with no risk (which is impossible), then yes, that would change the market.
- Lazare 4y ago
  Custodia would not have paid interest, and indeed, that's impossible. Functionally, Custodia was offering a "we'll park your cash in a safety deposit box in exchange for a fee" service, except offered by a dodgy outfit with a lot of crypto links. Now narrow banks - as proposed by, among others, TNB USA - would be effectively entirely safe and could pay interest. Efforts to set one up were shut down by the Fed because they would, in fact, be too attractive compared to traditional banks. See, eg, https://www.bloomberg.com/opinion/articles/2019-03-08/the-fed-versus-the-narrow-bank https://www.bloomberg.com/opinion/articles/2019-03-08/the-fe...
- deleted 4y ago
  [deleted]
koolba 4y ago
I’d rather have my money backed by someone with nukes and a printing press than held over collateralized by one party.
- anonporridge 4y ago
  You have that privilege as an individual likely holding much less than $250,000 in cash at any time, but large institutions holding millions in cash don't, as the big customers of SVB almost found out before the Fed did their "surprise, we'll actually ensure 100% of everyone's money in this super special case, but just the one time ;)"
  - coffeebeqn 4y ago
    The solution should be fully insured up to any amount Fed bank accounts. Not more crypto nonsense that’ll blow up in a few years once the owners realize they could be making more easy money
Lazare 4y ago
> You can't have one bank totally safe from bank runs in an environment where every other bank keeps less than 10% of your cash on reserve. This breaks the system. Either everyone has to be fractional reserve, or no one can be. That's a somewhat absurd assertion. There's nothing about paying a bank a fee to keep your cash in a safe deposit box which is 1) novel 2) attractive or 3) at odds with a large system of fractional reserve banking. "You can pay some oddball special purpose depository institution in Wyoming to hold onto your money for you, but they're a bit dodgy and have a bunch of weird ties to crypto. And if they lose it, it's not insured by FDIC. Or you can put it in JP Morgan, and they'll pay you interest, and balances up to $250k are insured by FDIC, although realistically JP Morgan is very, very much too big to be allowed to fail, so the odds of those limits very relevant is almost precisely nil." If that choice seems at all tricky to you, much less if your answer is "Custodia", you need to realise what an incredibly tiny minority that places you in. Now, what is a threat to the banking system are narrow banks; for more on that see, eg, Matt Levine a few years ago: https://www.bloomberg.com/opinion/articles/2019-03-08/the-fed-versus-the-narrow-bank https://www.bloomberg.com/opinion/articles/2019-03-08/the-fe... The Fed was pretty clear that they were refusing to allow this business model because it was, in part, too safe. :)
- tintweezl 4y ago
  A way to do it, not saying this is their model I haven't looked into Custodia at all. But just for the sake of argument, would be to start out capitalized with X amount of cash which would allow 12.5X in deposits to be fully covered. As fees are generated and/or stock issued and sold, more deposits could be accepted. If this model were competing with traditional 10% margin banks, it might well be supported by stockholders due to its ability to withstand runs a priori.
  - Lazare 4y ago
    Again though - let's say you do that, and then it turns out that someone has stolen a bunch of the cash - enough to burn through the overcapitalisation. If the bank isn't insured, then depositors end up taking losses, which means that - certainly for people with less than $250k of deposits - this "safe" bank is strictly less safe than a traditional bank. (And realistically, almost certainly less safe for large depsositors too.) So why would you pay money for a strictly inferior experience as a depositor when a traditional bank would pay you? And if the bank is insured, then you've got to cover the insurance fees out of the fees you collect from depositors. And the insurance is presumably either FDIC, or something which is some mixture or less generous and/or more risky (FDIC is backstopped by the US government; Joe's Discount Deposit Insurance Agency...isn't.). But even in the best case it's FDIC, in which case...what's the point? You're exactly as safe as a traditional bank, except you're refusing to make loans, so you have to charge your depositors fees. > If this model were competing with traditional 10% margin banks, it might well be supported by stockholders due to its ability to withstand runs a priori. It is true that while these models have no benefit to depositors, they nominally benefit shareholders, we are going to be wiped out in fewer cases. (Note, though, that a bank with this model can't neccessarilly withstand runs. Let's say a false rumour sweeps through that one of these banks has had money stolen from the vaults. People correctly realise that if this is true, and they're the last ones to withdraw money, there will be nothing left for them, so the race to withdraw first. Unlike a traditional bank, in this case all the deposits can be returned, but now you've got a bank with branches and staff but no depositors and thus no revenue. And the panicked depositors who pulled their money out and put it in some other bank will have no incentive to bring it back now that you've proven you could cover the deposits. Bankruptcy is likely inevitable at this point.) But in any case, sure, given the same risk adjusted return, it's rational to always prefer equity in something like Custodia than a traditional bank! But since there's no benefit to depositors, there's no way a bank could make an equivalent return. And while plenty of investors do want low risk, low return investments, it's hard to imagine any of them taking a flyer on something like Custodia, which is likely to be the exact opposite of that. None of this actually works.
kasey_junk 4y ago
Narrow banks are only protected from credit and interest rate risk. Operational risk is still a concern and one that brings down many traditional banks. If a manager runs off with 9% of the funds, or if other liabilities cause the bank to be insolvent a bank run is still possible and an orderly receivership would be needed to ensure that depositors were paid out before other creditors. Deposit insurance is one of the mechanisms that the banking system use to pay out depositors swiftly (usually next business day after receivership). Traditional bankruptcy proceedings could leave depositors waiting for years for their funds, which is a reasonable risk to be concerned about.
- zarzavat 4y ago
  Is there no organizational structure that can solve this? For example, have two entities: a backend entity for deposits (a trust), and frontend entity for the day-to-day administration of bank activities, such as marketing etc.
lxgr 4y ago
Serious question: How does a bank keep "cash on hand"? Was the plan to keep all USD deposits in Fed balances? > I suspect they aren't talking about runs and contagions on Custodia, but runs and contagions on all other banks if Custodia were allowed to exist. You can't have one bank totally safe from bank runs in an environment where every other bank keeps less than 10% of your cash on reserve. This breaks the system. Either everyone has to be fractional reserve, or no one can be. Why? As long as my bank pays more interest on my (insured) deposits than a hypothetical full-reserve alternative, why would I switch to them? Why would anybody (below FDIC limits)?
- mike_d 4y ago
  > Serious question: How does a bank keep "cash on hand"? Was the plan to keep all USD deposits in Fed balances? Banks keep cash on hand inside vaults, on deposit at their local Federal Reserve Bank, "in transit" (stored at an armored car company), or in accounts at correspondent institutions internationally (primarily for settling debits and credits on international wires).
  - lxgr 4y ago
    The only one of these that makes sense is a Fed balance (as it is not only free but even pays interest), but the Fed does not seem to be a fan of the idea [1]. Cash in vaults has negative yield (the vault itself isn't free, nor is insurance for it), and if you don't like fractional reserve banking and/or counterparty risk, foreign correspondent banks don't really seem like a good way to eliminate it either. [1] https://www.bloomberg.com/opinion/articles/2019-03-08/the-fed-versus-the-narrow-bank https://www.bloomberg.com/opinion/articles/2019-03-08/the-fe...
    - mike_d 4y ago
      I'm not sure what you are criticizing specifically, I just answered the question of how banks hold cash.
      - lxgr 4y ago
gerad 4y ago
How do they keep $1.08 for every $1 deposited? Do they have some sort of magic money printing machine? Or do I deposit a dollar and only get ~$0.92 in my account? If the latter, that seems like a pretty bad deal.
- lxgr 4y ago
  I suppose the 8 cents could be shareholder capital? It's a pretty unclear why anybody would want to be a shareholder, though.
  - unmole 4y ago
    > It's a pretty unclear why anybody would want to be a shareholder, though. Yeah. It doesn't sound like a great idea. Sure, the bank can charge fees for maintaining accounts. But what do you do if you suddenly have a large influx of deposits? To maintain the 108% ratio you'd have to raise additional capital, fine. But what happens when deposits fall? Presumably that would reduce the fees collected and thereby reduce earnings per share with no feasible way getting out of the situation.
    - UncleMeat 4y ago
      Especially given that you’d need to be an interesting person to choose to keep your cash in a bank account that charges a fee rather than pays interest in todays world.
    - rrobukef 4y ago
      ""Due to a larger than expected number of deposits we are obligated to introduce an 8% increase deposit limit fee.""
      - lxgr 4y ago
        I suppose they could make holding stock mandatory too…?
SideQuark 4y ago
So if people suddenly put 1 trillion in the bank magically makes up 8% of that out of nowhere? Yeah, it's an absurd claim and the Fed is correct in denying it. It's welcome to exist somewhere people will believe it has magic money printing mechanisms. Heck, if it worked, the bank could put in $1m, suddenly have $1.08m, invest that in the same money magic mill repeatedly, and soon have all the money it wanted. All this on the "promise" that nothing will go bad.... Sorry, the purpose of insurance is to share volatility, and it works quite well. The purpose of claims like Custodia is making is to skirt regulations that exist for solid, historically demonstrated, reasons, so they can play loose with people's money.
- matt_kantor 4y ago
  I know nothing about Custodia, but I'd guess they either wouldn't accept your deposit or would charge an 8% fee on it.
- SpaghettiCthulu 4y ago
  Maybe I'm misunderstanding, but I think the point is that there would be fees to ensure that they always have an extra $0.08 on hand for every $1 you put in. Not sure what that would look like. Maybe a fee on every deposit?
  - dragontamer 4y ago
    Maybe the details of how it worked were absurd and unworkable and the FDIC shit it down. Occam's razor.

IAmGraydon 4y ago

Fractional reserve allows banks to return some of their gains to the customer via interest. Does Custodia do that? If not, it's clear that they can both exist in the same market as they both offer different levels of risk and return. If Custodia were to pay interest with no risk (which is impossible), then yes, that would change the market.

Lazare 4y ago
Custodia would not have paid interest, and indeed, that's impossible. Functionally, Custodia was offering a "we'll park your cash in a safety deposit box in exchange for a fee" service, except offered by a dodgy outfit with a lot of crypto links. Now narrow banks - as proposed by, among others, TNB USA - would be effectively entirely safe and could pay interest. Efforts to set one up were shut down by the Fed because they would, in fact, be too attractive compared to traditional banks. See, eg, https://www.bloomberg.com/opinion/articles/2019-03-08/the-fed-versus-the-narrow-bank https://www.bloomberg.com/opinion/articles/2019-03-08/the-fe...
deleted 4y ago
[deleted]

koolba 4y ago

I’d rather have my money backed by someone with nukes and a printing press than held over collateralized by one party.

anonporridge 4y ago
You have that privilege as an individual likely holding much less than $250,000 in cash at any time, but large institutions holding millions in cash don't, as the big customers of SVB almost found out before the Fed did their "surprise, we'll actually ensure 100% of everyone's money in this super special case, but just the one time ;)"
- coffeebeqn 4y ago
  The solution should be fully insured up to any amount Fed bank accounts. Not more crypto nonsense that’ll blow up in a few years once the owners realize they could be making more easy money

Lazare 4y ago

> You can't have one bank totally safe from bank runs in an environment where every other bank keeps less than 10% of your cash on reserve. This breaks the system. Either everyone has to be fractional reserve, or no one can be. That's a somewhat absurd assertion. There's nothing about paying a bank a fee to keep your cash in a safe deposit box which is 1) novel 2) attractive or 3) at odds with a large system of fractional reserve banking. "You can pay some oddball special purpose depository institution in Wyoming to hold onto your money for you, but they're a bit dodgy and have a bunch of weird ties to crypto. And if they lose it, it's not insured by FDIC. Or you can put it in JP Morgan, and they'll pay you interest, and balances up to $250k are insured by FDIC, although realistically JP Morgan is very, very much too big to be allowed to fail, so the odds of those limits very relevant is almost precisely nil." If that choice seems at all tricky to you, much less if your answer is "Custodia", you need to realise what an incredibly tiny minority that places you in. Now, what is a threat to the banking system are narrow banks; for more on that see, eg, Matt Levine a few years ago: https://www.bloomberg.com/opinion/articles/2019-03-08/the-fed-versus-the-narrow-bank https://www.bloomberg.com/opinion/articles/2019-03-08/the-fe... The Fed was pretty clear that they were refusing to allow this business model because it was, in part, too safe. :)

tintweezl 4y ago
A way to do it, not saying this is their model I haven't looked into Custodia at all. But just for the sake of argument, would be to start out capitalized with X amount of cash which would allow 12.5X in deposits to be fully covered. As fees are generated and/or stock issued and sold, more deposits could be accepted. If this model were competing with traditional 10% margin banks, it might well be supported by stockholders due to its ability to withstand runs a priori.
- Lazare 4y ago
  Again though - let's say you do that, and then it turns out that someone has stolen a bunch of the cash - enough to burn through the overcapitalisation. If the bank isn't insured, then depositors end up taking losses, which means that - certainly for people with less than $250k of deposits - this "safe" bank is strictly less safe than a traditional bank. (And realistically, almost certainly less safe for large depsositors too.) So why would you pay money for a strictly inferior experience as a depositor when a traditional bank would pay you? And if the bank is insured, then you've got to cover the insurance fees out of the fees you collect from depositors. And the insurance is presumably either FDIC, or something which is some mixture or less generous and/or more risky (FDIC is backstopped by the US government; Joe's Discount Deposit Insurance Agency...isn't.). But even in the best case it's FDIC, in which case...what's the point? You're exactly as safe as a traditional bank, except you're refusing to make loans, so you have to charge your depositors fees. > If this model were competing with traditional 10% margin banks, it might well be supported by stockholders due to its ability to withstand runs a priori. It is true that while these models have no benefit to depositors, they nominally benefit shareholders, we are going to be wiped out in fewer cases. (Note, though, that a bank with this model can't neccessarilly withstand runs. Let's say a false rumour sweeps through that one of these banks has had money stolen from the vaults. People correctly realise that if this is true, and they're the last ones to withdraw money, there will be nothing left for them, so the race to withdraw first. Unlike a traditional bank, in this case all the deposits can be returned, but now you've got a bank with branches and staff but no depositors and thus no revenue. And the panicked depositors who pulled their money out and put it in some other bank will have no incentive to bring it back now that you've proven you could cover the deposits. Bankruptcy is likely inevitable at this point.) But in any case, sure, given the same risk adjusted return, it's rational to always prefer equity in something like Custodia than a traditional bank! But since there's no benefit to depositors, there's no way a bank could make an equivalent return. And while plenty of investors do want low risk, low return investments, it's hard to imagine any of them taking a flyer on something like Custodia, which is likely to be the exact opposite of that. None of this actually works.

kasey_junk 4y ago

Narrow banks are only protected from credit and interest rate risk. Operational risk is still a concern and one that brings down many traditional banks. If a manager runs off with 9% of the funds, or if other liabilities cause the bank to be insolvent a bank run is still possible and an orderly receivership would be needed to ensure that depositors were paid out before other creditors. Deposit insurance is one of the mechanisms that the banking system use to pay out depositors swiftly (usually next business day after receivership). Traditional bankruptcy proceedings could leave depositors waiting for years for their funds, which is a reasonable risk to be concerned about.

zarzavat 4y ago
Is there no organizational structure that can solve this? For example, have two entities: a backend entity for deposits (a trust), and frontend entity for the day-to-day administration of bank activities, such as marketing etc.

lxgr 4y ago

Serious question: How does a bank keep "cash on hand"? Was the plan to keep all USD deposits in Fed balances? > I suspect they aren't talking about runs and contagions on Custodia, but runs and contagions on all other banks if Custodia were allowed to exist. You can't have one bank totally safe from bank runs in an environment where every other bank keeps less than 10% of your cash on reserve. This breaks the system. Either everyone has to be fractional reserve, or no one can be. Why? As long as my bank pays more interest on my (insured) deposits than a hypothetical full-reserve alternative, why would I switch to them? Why would anybody (below FDIC limits)?

mike_d 4y ago
> Serious question: How does a bank keep "cash on hand"? Was the plan to keep all USD deposits in Fed balances? Banks keep cash on hand inside vaults, on deposit at their local Federal Reserve Bank, "in transit" (stored at an armored car company), or in accounts at correspondent institutions internationally (primarily for settling debits and credits on international wires).
- lxgr 4y ago
  The only one of these that makes sense is a Fed balance (as it is not only free but even pays interest), but the Fed does not seem to be a fan of the idea [1]. Cash in vaults has negative yield (the vault itself isn't free, nor is insurance for it), and if you don't like fractional reserve banking and/or counterparty risk, foreign correspondent banks don't really seem like a good way to eliminate it either. [1] https://www.bloomberg.com/opinion/articles/2019-03-08/the-fed-versus-the-narrow-bank https://www.bloomberg.com/opinion/articles/2019-03-08/the-fe...
  - mike_d 4y ago
    I'm not sure what you are criticizing specifically, I just answered the question of how banks hold cash.
    - lxgr 4y ago

gerad 4y ago

How do they keep $1.08 for every $1 deposited? Do they have some sort of magic money printing machine? Or do I deposit a dollar and only get ~$0.92 in my account? If the latter, that seems like a pretty bad deal.

lxgr 4y ago
I suppose the 8 cents could be shareholder capital? It's a pretty unclear why anybody would want to be a shareholder, though.
- unmole 4y ago
  > It's a pretty unclear why anybody would want to be a shareholder, though. Yeah. It doesn't sound like a great idea. Sure, the bank can charge fees for maintaining accounts. But what do you do if you suddenly have a large influx of deposits? To maintain the 108% ratio you'd have to raise additional capital, fine. But what happens when deposits fall? Presumably that would reduce the fees collected and thereby reduce earnings per share with no feasible way getting out of the situation.
  - UncleMeat 4y ago
    Especially given that you’d need to be an interesting person to choose to keep your cash in a bank account that charges a fee rather than pays interest in todays world.
  - rrobukef 4y ago
    ""Due to a larger than expected number of deposits we are obligated to introduce an 8% increase deposit limit fee.""
    - lxgr 4y ago
      I suppose they could make holding stock mandatory too…?

SideQuark 4y ago

So if people suddenly put 1 trillion in the bank magically makes up 8% of that out of nowhere? Yeah, it's an absurd claim and the Fed is correct in denying it. It's welcome to exist somewhere people will believe it has magic money printing mechanisms. Heck, if it worked, the bank could put in $1m, suddenly have $1.08m, invest that in the same money magic mill repeatedly, and soon have all the money it wanted. All this on the "promise" that nothing will go bad.... Sorry, the purpose of insurance is to share volatility, and it works quite well. The purpose of claims like Custodia is making is to skirt regulations that exist for solid, historically demonstrated, reasons, so they can play loose with people's money.

matt_kantor 4y ago
I know nothing about Custodia, but I'd guess they either wouldn't accept your deposit or would charge an 8% fee on it.
SpaghettiCthulu 4y ago
Maybe I'm misunderstanding, but I think the point is that there would be fees to ensure that they always have an extra $0.08 on hand for every $1 you put in. Not sure what that would look like. Maybe a fee on every deposit?
- dragontamer 4y ago
  Maybe the details of how it worked were absurd and unworkable and the FDIC shit it down. Occam's razor.