Basel Oversight Committee Backs “Conservative” Crypto Capital Rules

The Group of Central Bank Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision, has endorsed a finalised prudential standard on banks’ cryptoasset exposures.

Under the standard, expected to be implemented by 1 January 2025, unbacked cryptoassets and stablecoins with ineffective stabilisation mechanisms will be subject to a conservative prudential treatment. GHOS says the standard “will provide a robust and prudent global regulatory framework for internationally active banks’ exposures to cryptoassets that promotes responsible innovation while preserving financial stability”.

GHOS members also tasked the Basel Committee with monitoring the implementation and effects of the standard.

The oversight body adds that while the global banking system’s direct exposures to cryptoassets remain relatively low, recent developments have further highlighted the importance of having a strong global minimum prudential framework for internationally active banks to mitigate risks from cryptoassets. To that end, the GHOS tasked the Basel Committee with continuing to assess bank-related developments in cryptoasset markets, including the role of banks as stablecoin issuers, custodians of cryptoassets and broader potential channels of interconnections.

More generally, the committee will continue to collaborate with other standard-setting bodies and the Financial Stability Board to ensure a consistent global regulatory treatment of stablecoins.

The original proposals from the Basel Committee have been the subject of two consultations after pushback from the banking industry in particular, which argued the proposed rules would effectively preclude banks from participating in the cryptoasset space to any meaningful degree. In the final standards, some of the concerns raised have been answered, but not all.

Specifically, a proposed fixed infrastructure “add-on” of 2.5% to risk-weighted assets has been watered down and replaced with a more flexible arrangement that allows authorities to initiate and increase an add-on based on any observed weaknesses in the infrastructure that underlies specific cryptoassets. “Such an approach should incentivise banks to actively address infrastructure risks to avoid the imposition of an add-on at a future point,” the committee points out.

The final proposal also removes what was termed the “basis risk test”, which is a quantitative test based on the market value of the cryptoasset, and aims to ensure that the holder can sell it in the market for an amount that closely tracks the peg value. At the same time, for cryptoassets that are pegged to one or more currencies, the redemption risk test now also includes a requirement that the reserve assets must be comprised of assets with minimal market risk and credit risk. The committee adds it will further study the appropriate composition of reserve assets for the purpose of the redemption risk test.

The proposed requirement for banks to keep their aggregate exposures to Group 2 cryptoassets below a threshold of 1% of their Tier 1 capital has been retained in the final standard, subject to certain modifications. The first modification will result in exposures being measured as the higher of the gross long and gross short position in each cryptoasset, rather than the aggregate of the absolute values of long and short exposures, as proposed in the second consultation. “This change will ensure that banks that take steps to hedge exposures are not penalised under the limit,” the committee says.

The second modification relates to the capital consequences of a breach of the limit. To reduce cliff effects, the committee has agreed that the consequence of breaching the limit will be for the Group 2b capital treatment to apply to only the amount by which the limit is exceeded, rather than to all Group 2 exposures. “However, to ensure that banks have a strong incentive to not significantly exceed the 1% threshold, a new 2% limit will be introduced which, if breached, will result in the whole of Group 2 exposures being subject to the Group 2b capital treatment,” it warns.

“It is important to continue to monitor bank-related developments in cryptoasset markets. We remain ready to act further if necessary”

Under the second consultation proposal, banks were required to assess their cryptoassets against the classification conditions and seek prior supervisory approval to finalise the classification. The committee says it agrees with feedback to the consultation that this process could be unnecessarily burdensome, particularly in cases where the compliance or breach of the conditions is clear. As a result, the required process has been modified to remove the supervisory pre-approval element; instead, in the final standard banks are required to notify supervisors of classification decisions and supervisors will have the power to override these decisions if they disagree with a bank’s assessment.

The final change is to meet concerns expressed after the second consultation about the application of the standard in relation to customer assets where a bank is acting as a custodian. The committee says respondents were concerned that the standard may imply the application of credit, market and liquidity risk requirements to those customer assets. “This was not the intention of the standard,” the committee states. “The standard has therefore been revised to clarify which elements are applicable to custodial services provided by banks.”

The initial impression from the final standard is that, as expected, the rules have been diluted somewhat, but probably not to the degree desired by the banking industry in particular. The fact that custodial services have been exempted largely from the credit, market and liquidity risk will be welcomed, as will the relief given to banks who attempt to hedge their cryptoasset positions.

“Today’s endorsement by the GHOS marks an important milestone in developing a global regulatory baseline for mitigating risks to banks from cryptoassets,” says Tiff Macklem, chair of GHOS and governor of the Bank of Canada. “It is important to continue to monitor bank-related developments in cryptoasset markets. We remain ready to act further if necessary.”