Today the Basel Committee on Banking Supervision (BCBS) outlined some suggested procedures for banks that have exposure to cryptocurrencies. The BCBS sets global regulatory standards for banks including the bank capital adequacy rules which were tightened after the 2008 banking crisis. This morning’s short announcement concluded that “the Committee will in due course clarify the prudential treatment of such exposures to appropriately reflect the high degree of risk of crypto-assets.”
A little speculation
Ledger Insight’s interpretation is there’s a good chance that “treatment” could involve additional capital requirements for bank cryptocurrency exposures. Given the volatility of cryptocurrencies the capital needs could be significant which would be a deterrent to adoption by financial institutions.
Additionally, any rules would require more formal definitions of crypto-asset types to differentiate between low risk tokenized versions of enterprise digital assets and the more volatile cryptocurrencies. For example, a tokenized listed stock might be considered a lower risk digital asset.
Many have previously written about token classifications, including some regulators. R3’s Todd McDonald wrote a blog post on the topic, and the Global Digital Finance group penned a paper dividing them into consumer tokens, payment tokens and financial asset tokens.
However, it’s not just a matter of what kind of token is being issued, but also by whom it has been issued. Back to the listed stock example, if the issuing company is doing the tokenization of a stock, then that may be relatively low risk. If a completely unrelated party is doing the tokenization, the risks may be more significant.
Back to the announcement
Even though the crypto-asset market remains small, the Basel Committee’s view is that new trading platforms and products stimulate growth which increases financial stability risks.
The BCBS uses the term crypto-assets in place of cryptocurrencies as the volatility of crypto means it’s not a currency.
Today’s announcement was brief but outlines the critical risks of bank exposure to cryptocurrencies. Those risks are: “liquidity risk; credit risk; market risk; operational risk (including fraud and cyber risks); money laundering and terrorist financing risk; and legal and reputation risks.”
As a result, the BCBS expects any bank that is getting involved in crypto-assets to take four steps at a minimum. Firstly due diligence to explore each of the above risks. Secondly, a bank has to ensure appropriate governance and risk management. The most obvious procedures include anti-money laundering and heightened fraud monitoring. And banks need to take steps to manage risk given the potential for substantial losses.
The other two steps relate to transparency. The BCBS says banks should publicly disclose material exposures to crypto-assets including accounting treatment. Additionally, a bank needs to inform its regulator of any existing or planned exposure to crypto-assets including its assessment of whether it’s within the regulations and the risk management previously mentioned.
The Committee is working with the Financial Stability Board and other standards-setting organizations to clarify the treatment of exposures. “The Committee will in due course clarify the prudential treatment of such exposures to appropriately reflect the high degree of risk of crypto-assets.”
Six weeks ago the Bank of International Settlements published a report on cryptocurrencies which concluded that “alternative technologies still need to demonstrate that they can function without institutional backing.”
