Basel Committee crypto asset prudential treatment proposals get detailed responses

The international financial community went long form to speak up for its interests as the Basel Committee on Banking Supervision continues to optimize banking regulation.

The comments period has ended for the Basel Committee on Banking Supervision (BCBS) “Second Consultation on the Prudential Treatment of Cryptoasset Exposures,” a document published in June 2022.

International financial associations had a lot to say in response to it. Several did so at once in a joint 84-page comment letter released Oct. 4. In addition, there were a few lone voices, although they did not differ significantly in content from the conclusions made by the joint associations.

All the commenters had the same basic message. Institute of International Finance (IIF) director of regulatory affairs Richard Gray, speaking on behalf of the joint associations working group that participated in the response letter, summed up the response when he told Cointelegraph in a statement:

“Banks are already experts at risk management and consumer protection.”

Some features and calibrations in the Second Consultation, according to the written response, “would meaningfully reduce banks’ ability to – and in some cases effectively preclude banks from – utilising the benefits of distributed ledger technology (“DLT”) to perform certain traditional banking, financial intermediation and other financial functions more efficiently.”

The iterative approach to reserve requirements

The Second Consultation is named in relation to a document published in June 2021 called “Prudential Treatment of Cryptoasset Exposures,” which itself was built on a 2019 document and the responses to it. In the 2021 paper, the Basel Committee on Banking Supervision divided crypto assets into groups and recommended different prudential treatment for each group.

Group 1 in the committee’s proposal consisted of crypto assets that can subject to at least equivalent risk-based capital requirements the Basel Framework. Group 1a consists of “digital representations of traditional assets using cryptography, Distributed Ledger Technology (DLT) or similar technology rather than recording ownership through the account of a central securities depository (CSD)/custodian.” Group 1b consists of stablecoins and has “new guidance on application of current rules to capture the risks relating to stabilisation mechanisms.”

Group 2 crypto assets were those that failed to meet any of several classification conditions. That included cryptocurrency. Those assets would be “subject to a newly prescribed conservative capital treatment.” The most salient new treatment was the 1,250% risk weight assigned to them, making it necessary for banks to hold capital equivalent in value to their exposure to the crypto in this class.

A recently released, undated BCBS document estimated bank exposure to crypto assets at the end of 2021 at 9.4 billion euros, or 0.14% of the total exposure of banks reporting crypto holdings. That figure drops to 0.01% as the crypto asset exposure of all banks monitored. Bitcoin (BTC) and Ether (ETH) made up almost 90% of that exposure.

Second iteration of the prudential treatment

After considering the comments to the 2021 paper, the BCBS made several changes to its proposals. These included the creation of a Group 2a of crypto assets that will be subject to modified market risk rules for meeting hedging recognition requirements. Group 2 crypto asset exposure is also limited to 1% of Tier 1 capital. A new, more liberal “narrowly passed” category was created for stablecoins, and Group 1 crypto assets were subject to an infrastructure risk add-on to risk-weighted assets.

The joint associations working group that responded to the Second Consultation differed slightly from those involved in the response to the first. The new lineup included the umbrella group Global Financial Markets Association, the Futures Industry Association, IIF, International Swaps and Derivatives Association, International Securities Lending Association, Bank Policy Institute, International Capital Markets Association and Financial Services Forum.

The authors of the response letter noted that a workable crypto asset prudential treatment is necessary for banks to engage the crypto sector, and without that, “un- and -lesser-regulated entities are likely to be predominant providers of cryptoasset-related services.” The letter went on to engage closely with the BCBS proposals, responding from the point of view of banks’ feasibility.

IIF’s Gray told Cointelegraph:

“We support a regulatory framework for cryptoassets that is appropriately conservative, but not so restrictive that it would effectively shut out involvement from banks. It is important for financial stability that regulated financial institutions are able to facilitate client activity in the crypto space.”

Besides technical issues such as determining an acceptable Tier 1 exposure to Group 2 crypto assets, the letter drew attention to areas where the scope of the proposed framework was unclear. The Japanese Bankers Association expressed similar concerns in its response to the Second Consultation. American Bankers Association senior vice president and policy counsel Hu Benton wrote a technically detailed assessment of the proposed rules as well.