The cryptoasset market has reached sufficient size that banking regulators are starting to look at the prudential standards for banks’ exposures to the asset class, and last week the Bank for International Settlements’ Basel Committee on Banking Supervision issued a consultation paper outlining a proposal for the prudential treatment of cryptoassets.
The paper says: “The committee is of the view that the growth of cryptoassets and related services has the potential to raise financial stability concerns and increase risks faced by banks.
“Certain cryptoassets have exhibited a high degree of volatility and could present risks for banks as exposures increase, including liquidity risk, operational risk, fraud and cyber risks, AML risk and legal and reputational risks.”
The committee is also concerned about consumer protection and the carbon footprint of cryptoasset production.
The BCBS says the basis of prudential treatment of bank exposures to cryptoassets should be same risk, same activity, same treatment”, which means a cryptoasset that provides equivalent economic functions and poses the same risks compared with a traditional asset should be subject to the same capital, liquidity and other requirements as the traditional asset.
The prudential framework should apply the framework of technology neutrality and not be designed to promote or discourage the use of specific technologies related to cryptoassets.
“The prudential treatment should, however, account for any additional risks arising from cryptoasset exposure relative to traditional assets,” the paper says.
The BCBS is also calling for new requirements for banks to disclose their cryptoasset exposures regularly.
The committee has two general classifications for cryptoassets: those that are tokenised traditional assets or have effective stabilisation mechanisms (group 1); and those that do not meet these conditions and would be subject to a more conservative capital treatment (group 2).
Cryptoassets in group 1 may be treated as equivalent to a traditional asset for the purpose of calculating minimum capital requirements for credit and market risk, as long as they pose the same level of risk.
Group 2 cryptoassets would have a risk weight of 1250 per cent applied to their value.
If banks are exposed to cryptoassets with stabilisation mechanisms they must have a monitoring framework to verify that the stabilisation is effective. Banks must also verify the ownership rights of any underlying traditional asset upon whose value the cryptoasset depends.
Banks must be satisfied that the network on which a cryptoasset operates, including its technology, is designed and operated to sufficiently mitigate and manage material risks.
Banks must also be satisfied that entities that execute redemptions, transfers or settlement finality of cryptoassets are regulated and supervised.
The paper also spells out the various responsibilities of banks and regulators, in particular how much a regulator can rely on the work of another regulator or a third-party assessor that may have better skills in assessing the risk of cryptoassets.
The proposed standard also covers the treatment of leverage and liquidity ratios, large exposures, reporting and review requirements
The committee has called for feedback on its proposals and has included a number of questions in the paper.