June 17, 2021
On June 10, 2021, the Basel Committee on Banking Supervision (BCBS) issued a public consultation on a proposal that would apply regulatory capital requirements for banks’ exposures to cryptoassets (the “Consultation”). While banks’ exposures to cryptoassets are currently limited, the BCBS is concerned about the “absolute size” and “rapid developments” of the cryptoasset market. In particular, the BCBS regards the growth of cryptoassets and related services as having the potential to raise financial stability concerns and increase risks faced by banks, including liquidity, credit, market, operational and legal and reputation risks.
To address the risks associated with cryptoassets, the BCBS is proposing a framework for the capital treatment of banks’ cryptoasset exposures. As discussed below, for cryptoasset exposures in the highest risk category, including bitcoin, a 1,250 percent risk weight would apply. In effect, this means that a bank would need to hold a dollar in capital for each dollar’s worth of bitcoin or certain other cryptocurrencies, assuming an eight percent minimum capital requirement under the Basel III capital standards.
The Consultation prescribes prudential treatment of cryptoassets based on whether such cryptoassets satisfy certain classification conditions, and cryptoassets are split into two groups: (i) those eligible for treatment under the existing Basel capital framework, with some modifications (“Group 1”) and (ii) others, such as bitcoin, that are subject to a new conservative prudential treatment (“Group 2”). Prudential requirements discussed in the Consultation would be applicable based on a cryptoasset’s categorization in either Group 1 or Group 2. The prudential requirements consist of the following:
As discussed in the Consultation, Group 1 cryptoassets would be subcategorized as tokenized traditional assets such as bonds, loans, equities, commodities or cash held in custody (“Group 1a cryptoassets”) or cryptoassets that are effective at all times in linking their value to an underlying traditional asset or a pool of traditional assets (i.e., so-called “stablecoins”) (“Group 1b cryptoassets”). Stabilization mechanisms that reference other cryptoassets as underlying assets (including those that reference other cryptoassets that have traditional assets as underlying) or use protocols to increase or decrease the supply of the cryptoasset are not considered to be Group 1b cryptoassets. The Consultation provides additional clarity as to what would constitute a Group 1b cryptoasset, including its transferability, settlement finality and redemption rights, among other characteristics.
Under the Consultation, banks would be responsible for assessing on an ongoing basis whether a cryptoasset is compliant with its classification conditions and demonstrating to supervisors how a cryptoasset fulfils these conditions. In meeting this requirement, the Consultation advises banks to have in place the appropriate risk management policies, procedures, governance, human and information technology capacities to evaluate the risks of engaging in cryptoasset activities, and implement these accordingly on an ongoing basis. The Consultation puts on bank supervisory agencies the onus of reviewing and assessing banks’ analysis and risk management and measurement approaches, and approving the bank’s demonstration of whether and how a cryptoasset qualifies as a Group 1 cryptoasset. A cryptoasset that does not qualify for Group 1 treatment must be classified as a Group 2 cryptoasset.
Group 1a cryptoassets would be subject to capital requirements at least equivalent to those of traditional assets (with further consideration for capital add-ons), while there would be new guidance on the application of current rules to capture the risks relating to stabilization mechanisms (with further consideration for capital add-ons) with respect to Group 1b cryptoassets. The Consultation acknowledges that it is not possible for the BCBS to set out the capital treatment for every type of cryptoasset structure, but provides illustrative examples. In addition, the Consultation notes that to calculate risk-weighted assets with respect to such cryptoassets, a bank must include in risk-weighted assets the sum of the following two amounts: (i) the risk-weighted assets applicable to a direct holding of the underlying traditional asset and (ii) the value of the cryptoasset holding multiplied by the risk weight applicable to an unsecured loan to the redeemer. In accordance with risk-weighting of exposures to traditional assets, the risk weights will depend on factors such as:
Group 2 cryptoassets, on the other hand, would receive new conservative prudential treatment based on a 1,250 percent risk weight applied to the maximum of long and short positions. Such requirements would only apply to those Group 2 cryptoassets that have not been deducted from Common Equity Tier 1 capital, such as those classified as intangibles under the applicable accounting framework. Funds of Group 2 cryptoassets, such as Group 2 cryptoasset ETFs, and other entities, the material value of which are primarily derived from the value of Group 2 cryptoassets, would be treated under this category. Equity investments, derivatives or short positions in these funds or entities must also be treated under this category.
Requirements under the existing Basel capital framework would be applied to all Groups with respect to other minimum requirements (leverage ratio, large exposures, liquidity ratios). The BCBS is of the view that cryptoassets would not qualify as eligible high-quality liquid assets, but such view is subject to reevaluation at a later date.
Supervisory review would also be conducted across all Groups through the provision of additional guidance to ensure that risks not captured under minimum (Pillar 1) requirements are assessed, managed and appropriately mitigated (including through capital add-ons). In addition, the Consultation envisions new requirements for banks to disclose information regarding cryptoasset exposures on a regular basis with respect to all Groups. The Consultation highlights several risks that are particularly acute with respect to cryptoassets, including:
Supervisors would have the authority to request banks to remediate deficiencies in their identification or assessment process of identified risks. Although supervisory actions may vary according to the circumstances, the types of responses that supervisors may consider are:
According to the Consultation, disclosure requirements with respect to bank exposures to cryptoassets or related activities should follow the general guiding principles for banks’ Pillar 3 disclosures under the existing Basel capital framework, including both quantitative and qualitative information. Such qualitative information would include:
Cryptoassets are rapidly evolving as an asset class, and the BCBS is of the view that policy development for cryptoasset exposures is likely to be an iterative process, involving more than one consultation. In the United States, the financial regulatory agencies are poised to increase their scrutiny of cryptoassets and related activities.