The Basel Committee on Banking Supervision (BCBS) has announced new guidelines for banks holding cryptoassets. The guidelines, part of the Basel III framework, are designed to provide clarity and reduce the risk of banks holding cryptocurrencies.
Under the new guidelines, banks will be required to allocate 1250% risk weight to cryptoassets that are not backed by fiat currency or gold, effectively treating them as the riskiest assets. Banks will also be required to hold capital reserves equal to the value of any Bitcoin or other cryptoasset they hold.
Under Basel II, banks were required to allocate capital to various risk categories, including credit risk, market risk, and operational risk. The amount of capital required for each risk category was based on the level of risk associated with each type of activity.
After the Financial Crisis in 2008, Basel III introduced in 2010 additional exigencies for the amount and quality of capital banks are required to hold. One significant change was the introduction of a new category of risk, known as «operational risk», which covers risks arising from internal processes, people, and systems, as well as external events.
With the recent changes to Basel III, the risk weightings for assets, including certain cryptoassets, have been revised. The changes mean that cryptoassets are now subject to different levels of risk-weightings depending on their characteristics and intended use. For example, certain stablecoins, which are cryptoassets that are pegged to the value of a fiat currency or another asset, may be eligible for lower risk-weightings if they meet certain criteria, such as having a high degree of price stability and being redeemable at par on demand.
Main elements for treating banks´ cryptoasset exposures:
Basel Committee for Banking Supervision: Prudential treatment of crypto-asset exposures, December 2022
The Group 1 classification under Basel III includes tokenized traditional assets and stablecoins, with four classification conditions that ensure they pose a lower risk. These conditions include legally enforceable rights, risk mitigation in the underlying network, anti-money laundering considerations, and soundness of technology arrangements. Group 1 cryptoassets are subject to capital requirements based on the risk weights of the underlying traditional assets, with an additional capital requirement add-on if weaknesses in the infrastructure are observed.
Group 2 consists of all cryptoassets that do not meet any of the four classification conditions. This includes tokenized traditional assets and stablecoins with ineffective stabilization mechanisms, as well as unbacked cryptoassets such as Bitcoin. These cryptoassets are subject to a conservative capital treatment with a risk weight of 1250%, reflecting the potential for greater volatility and the difficulty of accurately valuing these assets compared to Group 1 assets.
For Group 2 assets that meet certain hedging recognition criteria, a limited degree of hedging is permitted, they are classified as Group 2a and banks can allocate a lower risk weight of 800% to stablecoins that meet certain criteria, such as being pegged to a fiat currency and having a reserve of high-quality liquid assets. These criteria also include thresholds related to market capitalization, trading volume, and price observations.
The BCBS standard also includes an exposure limit for Group 2 cryptoassets. Banks are constrained to hold the total amount of Group 2 cryptoassets below 1% of Tier 1 capital. If banks breach the 1% limit, the more conservative Group 2b capital treatment will apply to the amount above 1%. If the 2% limit is breached, the entire Group exposures will be subject to the Group 2b capital treatment to ensure banks have strong incentives to not significantly exceed the 1% threshold. This measure aims to prevent the transmission of shocks from the crypto-asset market to the banking sector and mitigate future financial stability risks.
The changes to the capital risk allocation under Basel III reflect the growing importance of cryptoassets and the need to ensure that banks are appropriately managing the risks associated with these assets. By introducing more nuanced risk-weightings for different types of cryptoassets, the updated framework aims to promote financial stability while also allowing banks to participate in the growing cryptoasset market.
The Basel Committee has also stated that it will continue to monitor the implementation and effects of the cryptoasset standard, and may issue additional refinements and clarifications over time.
The new guidelines provide greater clarity and certainty for banks holding cryptoassets, while also ensuring that appropriate risk management measures are in place. While some in the crypto community have criticized the guidelines as too restrictive, others see them as a necessary step towards greater mainstream adoption and acceptance of cryptocurrencies.
Sebastian KHL Berquet | CEO & Founder Berquet & Co. Consulting
References:
-Crypto-assets: a new standard for banks, ECB, Banking Supervision, 15.02.2023, https://www.bankingsupervision.europa.eu/press/publications/newsletter/2023/html/ssm.nl230215_1.en.html
-Basel Committee for Banking Supervision: Prudential treatment of crypto-asset exposures, December 2022
