Shearman & Sterling LLP | FinReg | Basel Committee on Banking Supervision Proposes Capital Requirements for Banks' Exposures to Crypto-Assets
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  • Basel Committee on Banking Supervision Proposes Capital Requirements for Banks' Exposures to Crypto-Assets

    The Basel Committee on Banking Supervision has launched a consultation on bank prudential requirements for exposures to crypto-assets. The consultation follows the Basel Committee's 2019 discussion paper on the prudential treatment of crypto-assets. This latest consultation sets out a preliminary proposal for the prudential treatment of crypto-assets, based on feedback to the discussion paper and other input from stakeholders. The Basel Committee believes that setting the policy will be an iterative process and that a further consultation will be needed. Responses to this consultation may be submitted until September 10, 2021.

    The Basel Committee considers that the increasing growth of crypto-assets raises financial stability concerns and is increasing the risks encountered by banks. Certain crypto-assets are highly volatile and may pose risks for banks as exposures increase, including liquidity risk, credit risk, market risk, operational risk, money laundering/terrorist financing risk, and legal and reputation risks.

    The Basel Committee is proposing different prudential approaches depending on whether a crypto-asset meets certain conditions. Crypto-assets that meet all of the conditions are referred to as Group 1 crypto-assets and are generally tokenized crypto-assets and stablecoins. Group 2 crypto-assets are all other crypto-assets, which are deemed to present additional and higher risks than Group 1 crypto-assets. The conditions that crypto-assets must fulfil for bank's exposure requirements to fall within Group 1 are:
    1. The crypto-asset either is a tokenized traditional asset or has a stabilization mechanism that is effective at all times in linking its value to an underlying traditional asset or a pool of traditional assets;
    2. 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;
    3. The functions of the crypto-asset 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; and
    4. Entities that execute redemptions, transfers or settlement finality of the crypto-asset are regulated and supervised.

    Banks would need to assess on an ongoing basis whether a particular crypto-asset meets the above conditions and be able to demonstrate that to their regulator. Banks will need to establish policies and procedures about the processes used to identify and assess the risks to crypto-assets or related activities. Central bank digital currencies are out of scope of the consultation paper.

    The proposed prudential treatment of exposures to Group 1 crypto-assets would be split between tokenized crypto-assets (Group 1a) and stablecoins (Group 1b). Exposures to tokenized crypto-assets could be treated at least equivalent to those of traditional assets for the purpose of calculating minimum capital requirements for credit and market risk. This would mean the same capital treatment as is applied to bonds, loans, deposits, equities, commodities or cash. A crypto-asset that must first be redeemed or converted into one of these traditional assets to receive the same legal rights as direct ownership of a traditional asset, would constitute a stablecoin. For exposures to stablecoins (Group 1b crypto-assets), the Basel Committee is proposing new guidance on the application of current rules to capture the risks relating to stabilization mechanisms. The Basel Committee notes that it is not possible to set out a capital treatment for every type of structure, and presents two stylized examples of stablecoin structures that illustrate how the rules would be applied. These examples are, according to the Committee, demonstrative of the issues that most stablecoin structures would present for bank exposures. Stablecoins would only fall within Group 1 if they are fully reserved at all times, which may increase the onerous monitoring requirements.

    Exposures to Group 2 crypto-assets would be subject to a new prudential regime. It is proposed that a risk weight of 1250 percent would apply for each Group 2 crypto-asset to which a bank is exposed. The aim is to capture both market and credit risk and there would not be any separate treatment for the trading book and banking book. This treatment would apply to Group 2 crypto-assets which have not been deducted from Common Equity Tier 1 capital and to funds of Group 2 crypto-assets and other entities, the material value of which is primarily derived from the value of Group 2 crypto-assets. The equity investments, derivatives or short positions in these funds or entities would also be included in this group.

    It is suggested that regulators would be able to tighten these capital treatments by, for example, banning model-based approaches for all banks or requiring longer liquidity horizons to be used in the standardized and internal models approaches. The Basel Committee is not proposing a new regime for other minimum capital requirements. Therefore, the existing Basel requirements for leverage ratio, large exposures and liquidity ratios would apply, with additional guidance where appropriate.

    It is also proposed that there will be new requirements for banks to regularly disclose information regarding their crypto-asset exposures. The disclosures would need to provide an overview of the bank's crypto-asset-related activities and the risks related to their crypto-asset exposures, including risk management principles.

    View the Basel Committee consultation paper on the prudential treatment of crypto-asset exposures.

    View details of the Basel Committee discussion paper on the prudential treatment of crypto-assets.

    You may like to view our client note on these proposals, "Global Banking Regulators Eye Capital Requirements for Banks' Cryptoasset Exposures".

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