To say the U.S. Federal Reserve System (“Fed”) is the most important financial institution in the world is not so much a bold claim as a banal statement of fact. Since the Fed’s initial charter in 1913, the U.S. economy has grown from roughly $500 billion in gross domestic product (“GDP”)—a comprehensive measure of economic activity1 would like to thank Andrew Wylie and W. Rives Fleming for their time and commentary, which were invaluable.—to more than $23 trillion, from less than 19% of the world’s GDP, to almost 25% of it, even while other Western countries shrunk comparatively.2See GDP (Current US$), World Bank, http://data.worldbank.org/indicator/NY.GDP
.MKTP.CD [http://perma.cc/B7P3-MJZJ] (reporting gross domestic product (“GDP”) for 2021); Angus Maddison, Contours of the World Economy, 1–2030 AD: Essays in Macro-Economic History 379, 381 (2007). The Fed’s first century of existence has not been without crises, however, and each crisis catalyzed systematic changes in the U.S. banking system, as well as accretion of the Fed’s power. The most recent economic downturns are no exceptions. In the wake of the 2008 financial crisis, Congress passed the Emergency Economic Stabilization Act (“EESA”) and authorized the Fed to begin paying interest on excess reserves3Since its charter, the Federal Reserve (“Fed”) has required banks to hold a percentage of their deposits in reserves—cash or deposits in their accounts at the Fed—to ensure banks can meet their liabilities in the case of sudden withdrawals. James Chen, Reserve Requirements: Definition, History, and Example, Investopedia, http://www.investopedia.com/terms/r/requiredreserves.asp [http://perma.cc
/CE8Q-4Z3T]. Excess reserves are those banks are not required to hold—money they choose to keep in their accounts at the Fed. James Chen, Excess Reserves: Bank Deposits Beyond What Is Required, Investopedia, http://www.investopedia.com/terms/e/excess_reserves.asp [http://perma.cc/5VDN-SD
6X]. In response to the COVID-19 pandemic, the Fed reduced the reserve requirement to 0%, effectively eliminating it. Reserve Requirements, Bd. Governors Fed. Rsrv. Sys., http://www.federalreserve.gov
/monetarypolicy/reservereq.htm [http://perma.cc/9VRK-HWJU]; see 12 C.F.R. § 204.4 (2023). As of March 2023, the Fed has not announced a return of the reserve requirement to historical levels. (“IOER”4Interest on Reserve Balances (“IORB”) replaced Interest on Excess Reserves (“IOER”) and Interest on Required Reserves (“IORR”) on July 29, 2021. Interest on Reserve Balances (IORB) Frequently Asked Questions, Bd. Governors Fed. Rsrv. Sys., http://www.federalreserve.gov/monetary
policy/iorb-faqs.htm [http://perma.cc/9VRK-HWJU]. The change, however, would not have affected The Narrow Bank’s (“TNB”) business model. To avoid confusion, this Note uses IOER when referencing any date before July 29, 2021, and it uses IORB when referencing any date after July 29, 2021.). For the first time, a commercial bank5“A financial institution that accepts deposits, offers checking account services, makes various loans, and offers basic financial products . . . .” Julia Kagan, How Do Commercial Banks Work, and Why Do They Matter?, Investopedia, http://www.investopedia.com/terms/c/commercialbank.asp [http://
perma.cc/6BTL-FC86]. could earn interest by holding its reserves instead of loaning them out, a complete inversion of the traditional banking model. And unlike interest on loans, IOER was a virtually riskless income stream.6See infra note 94.
One corporation saw the potential for a viable full-reserve, or “narrow,” bank that would not lend any money, but instead collect IOER and pay depositors above-market interest on their savings, profiting a modest difference. The Narrow Bank (“TNB”) received a temporary endorsement from its state chartering authority, yet its business model was dependent on a master account7“[A] master account is both a record of financial transactions that reflects the financial rights and obligations of an account holder and of the Reserve Bank with respect to each other, and the place where opening and closing balances are determined. For each institution, all credits and debits resulting from the use of Federal Reserve services at any Federal Reserve office are booked to this single master account at one Reserve Bank.” Bd. of Governors of the Fed. Rsrv. Sys., Reserve Maintenance Manual 5 (2019). Put simply, a master account is a bank account for banks. at the Fed. After long deliberation, the Fed expressed concerns about TNB’s business model and opted to continue evaluating the bank’s economic implications. TNB sought a declaratory judgement of its entitlement to a master account, but its complaint was dismissed because the Fed did not officially reject its application but rather declined to rule on it.
On its face, the challenge to a central bank’s discretion in determining which institutions can avail themselves of its services may seem arcane, inconsequential, and distant from the legal issues that affect most Americans. Its consequences, however, are broad and far-reaching. Since the Fed began paying IOER, interest paid on retail (consumer) savings accounts and certificates of deposits (“CDs”) has lagged significantly. TNB, on the other hand, was designed to pass nearly all of its earned interest to account holders, providing them a more attractive savings option and incentivizing them to save more—a nudge toward financial security in a country where the median family’s bank account balances total $8 thousand.8Fed. Rsrv. Sys., Changes in U.S. Family Finances from 2019 to 2022 18 (2023).
The Fed’s opposition to TNB was rooted in concerns that a full-reserve bank could destabilize the economy by challenging the Fed’s ability to regulate liquidity and interest rates. But beyond the economic effects of full‑reserve banking, which have been debated by scholars for almost a century, the conflict between TNB and the Fed raises important, relatively unexplored legal issues and implicates sociopolitical questions related to fairness and federalism. This Note contributes to full-reserve banking scholarship by exploring those legal and social topics and situating them in an assessment of full-reserve banking’s future, using TNB USA Inc. v. Federal Reserve Bank of New York, No. 18-cv-7978, 2020 U.S. Dist. LEXIS 62676 (S.D.N.Y. Mar. 25, 2020), as a guidepost.
The Note proceeds in three parts. Part I examines the history of the U.S. banking system and, in particular, the Fed. It also introduces full-reserve banking and outlines economic arguments for and against its adoption. Part II analyzes TNB USA and the legality of the Fed’s decision to deny TNB a master account. Part III explores the future of full-reserve banking in the United States, explains its relevance, and argues that the Fed’s restrictions on full-reserve banking are undesirable from legal and social perspectives because they rob start-up banks and depositors of the opportunity to capitalize on programs that perpetually benefit large, legacy financial institutions. A short conclusion follows.
