Today the Basel Committee on Banking Supervision published a consultation on capital requirements for crypto asset risk exposures. It proposes a 1250% risk weighting for cryptocurrency exposures, discouraging banks from exposing themselves to the risks. Requirements for tokenized conventional assets are not as steep, but stablecoin risk weightings are not as little as one might expect.
Basel III requires banks to set aside additional capital based on the risks they take. Generally, the higher the risk, the higher the return, and Basel aims to reign in that risk appetite.
To put the crypto risk weighting figure in context, holdings in U.S. Treasuries are treated as having 0% risk weighting and the most extreme risks attract 1250%.
Residential mortgages typically have a 50% risk weighting and publicly traded equities have a 300% risk weighting. Highly leveraged investment funds attract a 600% risk weighting. The figure of 1250% is usually for securities trades that are very overdue for payment. Or a securitized asset where the bank’s claim on the asset is at the back of the queue.
Basel III is pretty complex, and the above is an oversimplification.
A lot of Basel III rules, particularly for funds, require one to look through the fund at the underlying asset.
This raises an interesting point about MicroStrategy, the software firm that has invested billions in Bitcoin and just raised another round of debt to invest even more. Banks have used it as a surrogate to invest in the cryptocurrency asset class, presumably on behalf of clients. For Basel III risk weighting, would it be treated as a fund or a publicly-traded company?
Stablecoin risk weighting is not that small
In today’s paper, the Basel Committee split cryptoassets into two buckets. The first, lower risk group is for tokenized traditional assets such as stocks or bonds, or a stablecoin. Cryptocurrencies fall into the second group.
The stablecoin risk weighting is not insignificant. It is the sum of the risk associated with the backing asset plus a risk weighting as if a bank had granted an unsecured loan to the stablecoin holder. Looking at it from a bank’s perspective, this seems to make unsecured lending relatively more attractive because the return on that lending is likely to be higher than the stablecoin return.
To attract the lower risk treatment (compared to cryptocurrencies), tokenized assets have to meet certain requirements. For example, stablecoins must be fully redeemable and any organizations involved in redemption, transfers, or settlement must be regulated.
For tokenized assets such as stocks or bonds, it proposes the existing rules for traditional assets should apply, potentially with an uplift for any additional operating risk. That might include a different risk for a permissionless versus a permissioned blockchain. If a tokenized version is less liquid than a traditional asset, that would also require an additional risk weighting.
The Basel Committee is seeking responses to the consultation by September 10.
