Prudential Framework for Crypto Assets

Financial markets are moving towards closer integration with crypto assets as the global regulators and bodies are taking various steps towards it. Basel Committee is working with Industry to identify and develop global minimum standards for mitigating the risk arising from crypto assets to banking system.  BIS is of the view that currently exposure of banks to crypto assets is limited in nature however the exposure becomes meaningful when measured in absolute value and the way crypto assets are growing, they pose risk to the financial stability of the banks. With an increased exposure to crypto assets, banks are susceptible to credit, liquidity, markets and other risk similar to one related to normal banking operations.   Crypto assets which provide economic functions equivalent to traditional assets and poses similar risks when compared with regular asset class, should be subject to the prudential framework including posing requirement of maintaining capital, liquidity etc in line with the normal baking assets and also taking into account the additional risk posed by such assets. Prudential framework should not encourage or discourage use of any specific technology and should be technology neutral.

If the paper turns into regulation and adopted by countries, banks will be subjected to increased capital requirement while dealing with crypto assets. Banks will have to classify the assets according to criteria i.e., whether the crypto asset is a tokenised traditional asset or has a stabilisation mechanism linked to an underlying traditional asset or a crypto asset which does not fall in any of the categories e.g. bitcoin. Banks will have the responsibility to observe and monitor the assets in terms of verification of ownership rights of underlying traditional assets, observing the stabilisation mechanism, verification that underlying physical assets are managed and stored properly. Interest and obligations related to crypto asset should be defined and legally enforceable in the jurisdictions of issuance as well as redemption.   

In relation to stability, there is a threshold of 10bps over and above the defined value i.e., the stability thresholds of the crypto assets will be around three times of the value of traditional assets and will be breached if the value of the crypto asset exceed more than 10 bps of this threshold.   Group 1 crypto Assets will be subject to the Basel Framework requirement and has to be allocated between banking and trading books and exposures has to be treated in line with the requirement of standardised or internal model-based approaches.

The technology on which crypto assets are based are new and evolving. This may results in unanticipated operational risk to the assets. There can be additional risk charge under Pillar 1 for all group 1 crypto assets.  

The consultation paper when become regulation will facilitate tokenisation of corporate bonds and other capital market instrument along with ecosystem for enabling banks to deal with wider pool fo digital assets and cryptocurrencies. It indicates  supervision mechanism for all the players in the process e.g. transfer and settlement systems, custodians of any underlying assets, intermediaries etc. Application of prudential framework will help bank to participate in the crypto assets, helping integration of crypto and mainstream financial system however various conditions can be very restrictive for banks to participate.  It has to be seen that 10bps comparison may not be practically feasible as   various stable coins e.g Tether, (USDT), SPDR Gold Trust (GLD), Vanguard Total Bond Market ETF (BND) etc have breached the expected threshold various times in the year. However we are at the beginning of crypto evaluation and BIS efforts will help in integrating financial markets with the digital assets markets.

Bureau Galactik Views

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