Global banking supervisor seeks views on the prudential treatment of crypto-assets
Banks with exposures to crypto-assets need to determine how to treat them for prudential purposes – for example, to meet capital and liquidity requirements. The primary global standard setter for the prudential regulation of banks is the Basel Committee on Banking Supervision (BCBS). Its current framework does not treat crypto-assets as a separate asset class. It is now consulting on whether and how to set specific standards for their treatment and has invited stakeholder comments by 13 March 2020.
In March 2019, the BCBS set out its supervisory expectations for firms with exposures to crypto-assets. In particular, it emphasised that crypto-assets are not money and warrant conservative prudential treatment. The BCBS has now published a discussion paper on a tailored prudential regulatory framework for crypto-assets.
General principles for a prudential standard
The current Basel framework does not include an asset class for crypto-assets, given their novelty. Therefore, the BCBS is considering whether and how to specify a new global prudential standard based on a set of general principles, including the following:
- a crypto-asset and a ‘traditional’ asset that are economically equivalent should not be treated differently for prudential purposes;
- certain types of crypto-assets could become systemically important and therefore the design of the prudential treatment of crypto-assets should be simple and flexible;
- complex internally-modelled approaches should not be used to calculate regulatory requirements;
- there may be merit in starting with specifying the prudential treatment for the types of crypto-assets that could be considered as ‘high-risk’ while continuing to assess the risk profile and appropriate treatment for other types of crypto-assets; and
- jurisdictions should be free to take a stricter approach (including prohibiting banks from having any exposures to crypto-assets).
Channels for bank exposures to crypto-assets
The BCBS notes that while banks currently have limited direct exposures to crypto-assets, there may be a number of channels, both direct and indirect, by which they could be exposed to the risks from crypto-assets. These could include issuing crypto-assets, validating crypto-asset transactions, direct ownership of crypto-assets, loans to fund investment in cryptoassets, taking crypto-assets as collateral, trading in crypto-assets (or crypto-asset derivatives), underwriting initial coin offerings, providing custody services, taking deposits from a reserve backing crypto-assets and using crypto-assets for internal operational purposes, among other things.
Prudential risks from crypto-assets
The BCBS has identified a number of risks arising from banks’ exposures to crypto-assets, including:
- Liquidity risk: Banks that hold crypto-assets may not be able to convert them into fiat currency at little or no loss of value in private markets, thereby exposing them to liquidity risk.
- Market risk: The high degree of volatility in the valuation and pricing of crypto-assets could expose banks to mark-to-market losses.
- Credit and counterparty credit risk: Both direct and indirect exposures to crypto-assets may be subject to credit risk.
The BCBS also highlighted other, more idiosyncratic risks that could be important in the context of crypto-assets such as cyber and operational risks, legal risks, reputational risks, third-party risks and implementation risks.
Example of potential treatment of high-risk crypto-assets
Whilst there is no clear definition of “high-risk crypto-assets”, the BCBS provides a list of characteristics that would affect the risk profile of crypto-assets such as their creation (whether they are backed by an issuer), their user base and the legal regime that applies to their ecosystem.
Building on the general principles, the BCBS invites views on an illustrative example of how a bank’s exposure to a high-risk crypto-asset may be treated. Under the example, the BCBS proposes a conservative approach involving a full deduction of exposures in the banking book and a full deduction treatment for market risk and credit valuation adjustment (CVA) risk for exposures to such crypto-assets in the trading book.
Banks would not be permitted to use internal models for any high-risk crypto-asset exposures when calculating market risk, counterparty credit risk and CVA risk capital requirements and high-risk crypto-assets would not be eligible to serve as financial collateral for the purpose of the credit risk mitigation framework.
From a liquidity perspective:
- Liquidity Coverage Ratio (LCR): high-risk crypto-assets would not be eligible as high-quality liquid assets (HQLA) for the purpose of the LCR.
- Net Stable Funding Ratio (NSFR): high-risk crypto-assets would be subject to a 100% required stable funding factor, while high-risk crypto-asset liabilities with a residual maturity of less than one year would be subject to a 0% available stable funding factor.
Other exposures to crypto-assets
The BCBS is also consulting on bank exposures to other types of crypto-assets that could warrant a different treatment such as:
- crypto-assets used exclusively for intra-group and inter-bank settlements and are fully backed by fiat currency; and
- crypto-assets that use stabilisation tools linked to other assets (e.g. those that represent a claim on an underlying asset and are fully, irrevocably and verifiably backed by other tangible assets).
Pillar 2 – Supervisory Review and Evaluation Process
As discussed in the paper of March 2019, the BCBS expects banks to conduct adequate due diligence and assess risks from direct or indirect exposures to crypto-assets and inform their regulatory authorities of any actual or planned exposures.
Pillar 3 - Disclosure requirements
The BCBS proposes that banks are required to disclose any material crypto-asset holdings on a quarterly basis, which would include information on: (i) the exposure amounts of different direct and indirect crypto-asset exposures; (ii) the capital requirement for such exposures; and (iii) the accounting treatment of such exposures.
Stakeholders have until 13 March 2020 to provide their views on the BCBS’s proposals. After the consultation period, the BCBS will publish a paper with the main conclusions from the consultation and next steps. This could set out the minimum prudential standard discussed above.