The Basel Committee on Banking Supervision (BCBS) yesterday (10 June 2021) released a consultative document setting out preliminary proposals for the prudential (i.e. capital adequacy) treatment of banks’ cryptoasset exposures. A report I read in the financial press suggested that Basel was applying tough capital requirements to all cryptoassets but when you look at the actual proposals that is not correct (credit to Matt Levine at Bloomberg for picking up on the detail).
The BCBS is actually proposing to split cryptoassets into two broad groups:
- one which looks through the Crypto/DLT packaging and (largely) applies the existing Basel requirements to the underlying assets with some modifications; and
- another (including Bitcoin) which is subject to the new conservative prudential treatment you may have read about.
The proposed prudential treatment is based around three general principles
- Same risk, same activity, same treatment: While the the BCBS does see the “potential” for the growth of cryptoassets “to raise financial stability concerns and increase risks face by banks”, it is attempting to chart a path that is agnostic on the use of specific technologies related to cryptoassets while accounting for any additional risks arising from cryptoasset exposures relative to traditional assets.
- Simplicity: Given that cryptoassets are currently a relatively small asset class for banks, the BCBS proposes to start with a simple and cautious treatment that could, in principle, be revisited in the future depending on the evolution of cryptoassets.
- Minimum standards: Jurisdictions may apply additional and/or more conservative measures if they deem it desirable including outright prohibitions on their banks from having any exposures to cryptoassets.
The key element of the proposals is a set of classification conditions used to identify the Group 1 Cryptoassets
In order to qualify for the “equivalent risk-based” capital requirements, a crypto asset must meet ALL of the conditions set out below:
- The crypto asset either is a tokenised traditional asset or has a stabilisation mechanism that is effective at all times in linking its value to an underlying traditional asset or a pool of traditional asset
- All rights obligations and interests arising from crypto asset arrangements that meet the condition above are clearly defined and legally enforceable in jurisdictions where the asset is issued and redeemed. In addition, the applicable legal framework(s) ensure(s) settlement finality.
- The functions of the crypotasset and the network on which it operates, including the distributed ledger or similar technology on which it is based, are designed and operated to sufficiently mitigate and manage any material risks.
- Entities that execute redemptions, transfers, or settlement finally of the crypto asset are regulated and supervised
Group 1 is further broken down to distinguish “tokenised traditional assets” (Group 1a) and “crypto assets with effective stabilisation mechanisms” (Group 1b). Capital requirements applied to Group 1a are “at least equivalent to those of traditional assets” while Group 1b will be subject to “new guidance of current rules” that is intended to “capture the risks relating to stabilisation mechanisms”. In both cases (Group 1a and 1b), the BCBS reserves the right to apply further “capital add-ons”.
Crypto assets that fail to meet ANY of the conditions above will be classified as Group 2 crypto assets and subject to 1250% risk weight applied to the maximum of long and short positions. Table 1 (page 3) in the BCBS document offers an overview of the new treatment.
Some in the crypto community may not care what the BCBS thinks or proposes given their vision is to create an alternate financial system as far away as possible from the conventional centralised financial system. It remains to be seen how that works out.
There are other paths that may seek to coexist and even co-operate with the traditional financial system. There is also of course the possibility that governments will seek to regulate any parts of the new financial system once they become large enough to impact the economy, consumers and/or investors.
I have no insights on how these scenarios play out but the stance being adopted by the BCBS is part of the puzzle. The fact that the BCBS are clearly staking out parts of the crypto world they want banks to avoid is unremarkable. What is interesting is the extent to which they are open to overlap and engagement with this latest front in the long history of financial innovation.
Very possible that I am missing something here so let me know what it is …
Tony – From the Outside
From the outside 
BCBS engages in hand-waving by writing that the committee doesn’t like deductions as an alternative for 1,250% RW because … hold your breath … liabilities cannot be deducted from … liabilities. Wow! The next paragraphs pick up on that point by stipulating that crypto liabilities are akin to shorts, and could be addressed in Pillar 2, but that shows the choice for RWs for liabilities is fundamentally flawed.
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This goes with the narrative being played around CBDC’s – where the BIS sees a framework where both public (CBDC) and private stablecoins co-exist. The rules to ensure you get the same/same treatment makes a lot of sense and will help the public benefit from tech advancement and innovation done in the private sector, as long as it follows the rules, I guess the BIS realises that if they were to penalise this, it may thwart innovation and ultimately be a detriment to progress in this space. The proposal to treat the rest with a 1250% weighting seems a bit harsh, but probably sensible given it captures the entire bundle of “other crypto assets” – from Bitcoin to Dogecoin or whatever the latest crypto coin is. The only other way would be to be more complex (break down the crypto assets into risk classes/ratings) and given the limited exposure probably doesn’t warrant the time / effort. I will be interested to read the industry response and perspectives on this one…..especially from some of the banks /industry players potentially impacted by the harsh capital charge. This may force certain crypto industry players looking to integrate into traditional banking/finance to re-think and ultimately drive them to build that “alternate” financial system. An interesting one as one could argue, it might be better to have encouraged them to integrate and control, rather than let them loose….I suspect they don’t want to co-mingle the industries, but if the crypto financial markets keep evolving at current pace, they may not have much choice down the track.
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Thanks for those observations. One quick observation is that the BIS expectations for how private stablecoins should be backed seem to be more conservative than what the industry currently does. I am far from an expert in this domain (stablecoins) but even the fiat backed versions seem to have at best a 1:1 relationship of assets (or reserves) to the par value token issued. These assets are also often not high quality government bonds. Tether is a case in point where a lot of the reserve assets seem to be A2 rated CP. Assets like these would face very high haircuts if they were used to back a bank’s liquid asset requirement.
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