Basel Committee Seeks Strict Cryptoasset Capital Rules

On 10 June 2021, the Basel Committee on Banking Supervision (the Committee), made up of global central bankers and regulators from the world's leading financial centers, issued a public consultation on preliminary proposals for the prudential treatment of banks' cryptoasset exposures.

The Committee is of the view that the growth of cryptoassets (defined as private digital assets  that depend primarily on cryptography and distributed ledger or similar technology (FSB (2020)) and related services has the potential to raise financial stability concerns and increase risks faced by banks due to the high degree of price volatility of certain cryptoassets. These risks include liquidity risk; credit risk; market risk; operational risk (including fraud and cyber risks); money laundering/terrorist financing risk; and legal and reputation risks.

The consultation builds on prior related guidance from the Committee,  including a March 2019 newsletter that proposed minimum supervisory expectations for banks that are authorised, and decide, to acquire cryptoassets and/or provide related services,   and a December 2019 discussion paper seeking views of stakeholders on a range of issues related to the prudential treatment of cryptoassets.

A further public consultation on capital requirements is expected before final rules are published.  The Committee invites responses to the proposals by 10 September 2021.

What's New?

The Committee’s existing rules require banks to assign "risk weighting/s" to different types of assets on their books, which when aggregated, determine the bank’s overall capital requirements. The new proposal requires banks to set aside enough capital to cover in full any losses on cryptoassets holdings.

The Committee further notes that while bank exposure to cryptoassets is currently limited, continued growth in exposure could increase risks to global financial stability from fraud, cyber-attacks, money laundering, and terrorist finance if capital requirements are not introduced.

The Committee proposed segregating cryptoassets into two broad groups: those eligible for treatment under the existing Basel Framework with some modifications; and others, such as bitcoin, that are subject to a new conservative prudential treatment. The Committee summarised the general structure of proposal in the following table.

Group 1 cryptoassets. These fulfill all the classification conditions set out below and as such are eligible for treatment under the existing Basel Framework (with some modifications and additional guidance). 

• The cryptoasset either is a tokenised traditional asset or has a stabilisation mechanism that is effective at all times in linking its value to an underlying traditional asset or a pool of traditional assets. 
• All rights, obligations, and interests arising from cryptoasset 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. 
• The functions of the cryptoasset 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.
• Entities that execute redemptions, transfers, or settlement finality of the cryptoasset are regulated and supervised.

Group 2 cryptoassets. These, such as bitcoin, are cryptoassets that do not fulfill the classification conditions set out in No. 1 above. Since these pose additional and higher risks, they would be subject to a new conservative prudential treatment.

The application of existing Basel Framework requirements (e.g., leverage and liquidity ratios), will continue to apply to both groups of cryptoassets. Likewise, additional guidance to ensure that risks not captured under minimum (Pillar 1) requirements are assessed, managed, and appropriately mitigated (including through capital add-ons). New requirements for banks to disclose information regarding cryptoassets exposures on a regular basis will also cut across both groups.

Central bank digital currencies are not within the scope of the consultation.

Key Considerations

1. Banks will need to consider the adequacy and appropriateness of their governance, human, and IT capacities to evaluate the risks of engaging in cryptoassets.
2. Banks should establish policies and procedures that describe the processes used to identify and assess the risks that are unique to cryptoassets or related activities on an ongoing basis and implement these accordingly. 
3. Banks should assess, on an ongoing basis, whether a cryptoasset is compliant with the classification conditions; and demonstrate to supervisors how a cryptoasset fulfills these conditions.
4. Banks are also expected to inform their supervisory authorities of their policies and procedures, assessment results, as well as actual and planned cryptoasset exposures or activities in a timely manner and to demonstrate that they have fully assessed the permissibility of such activities, the associated risks and how they have mitigated such risks.
5. Banks with direct or indirect exposures to any form of cryptoasset should ensure that risks not captured under the Basel Framework are assessed, managed, and appropriately mitigated on an ongoing basis.
6. Banks should increase the surveillance of operational risk, including Information, Communication, and Technology (ICT) risk, encompassing governance requirements, risk management requirements on ICT risk, ICT-related incidents, requirements on testing of ICT tools and systems, and requirements on ICT third-party risk management.

Call To Action

Guidehouse professionals who collectively combine industry and consulting experience, including in cryptoassets, can help you develop and implement the systems, controls, policies, and procedures to meet the proposed cryptoassets requirements.

Guidehouse professionals help clients address their toughest challenges with a focus on markets and clients facing transformational change, technology-driven innovation, and significant regulatory pressure. Specifically, we have been engaged by banks, non-bank financial institutions, initial coin issuers and administrators, trading platforms, virtual commodity associations, digital asset exchanges, and money service agents. 

Please reach out to us if you would like to discuss further how we can assist you, to develop or review your regulatory or financial crime governance programme, or selected matters consequent of this proposal.