In December 2022, the Basel Committee on Banking Supervision (BCBS) announced a new standard for banks which sets a limit of 2% on crypto reserves, defines how to classify cryptocurrencies and makes provisions to minimize the risks associated with cryptocurrency exposure.
The new standard is an important landmark for financial institutions, as it provides essential clarity in crypto regulation and is expected to contribute to international regulatory harmonization.
The newly introduced guidance from Basel provides a globally consistent framework for regulating and supervising the activities of financial institutions in their treatment of crypto assets. It also aims to maintain financial stability and promote responsible innovation.
The Basel set of standards complements the forthcoming regulation of the cryptoasset sector through the Markets in Crypto-Asset regulation (MiCA), which was introduced on 9 June 2023.
What do the new Basel standards mean for banks and their approach to crypto assets?
Cryptocurrency classification
The Basel standard requires banks to classify cryptocurrencies on an ongoing basis. Following the guidance, cryptocurrencies are divided into two categories:
Group 1: Cryptocurrencies that are:
a) Less volatile crypto assets that are tokenized traditional assets, and
b) Crypto assets that have effective stabilization mechanisms.
Group 2: Those assets that fail to meet any of the classification conditions, including all unbacked crypto assets:
a) The assets where a limited degree of hedging is permitted, and
b) The assets where hedging is not recognized.
The final standard from Basel Committee on Banking Supervision also includes provisions that help minimize the risks associated with crypto asset exposure including:
- Provisions that address an infrastructure risk add-on;
- A redemption risk test and a supervision/regulation requirement;
- Descriptions of how the operational risk, liquidity, leverage ratio and large exposures requirements should be applied to banks’ cryptoasset exposures; a supervisory review process; and disclosure requirements.
How the Basel standard impacts the crypto industry
Despite the relatively low direct exposure of the global banking system to crypto assets, recent developments have highlighted the need for a robust global framework that enables active banks to manage their risks associated with this asset class.
To this end, the Basel Committee has been tasked with continuing to monitor the developments in the crypto asset markets. In addition to maintaining a comprehensive view of the various activities related to the sector, the Basel Committee will continue to examine the role of banks in the development of the industry. The Committee will continue to work with other standard-setters and the Financial Stability Board to ensure that stablecoins are treated in a consistent manner around the world.
This is a positive development as it allows the Basel Committee to monitor the evolving technology and the implementation of the Crypto Standard.
Strict requirements for crypto asset capital requirements
The Basel Committee is also expected to continue working with other regulators and the industry to ensure that the various aspects of the regulation of crypto assets are carried out manner consistently. This will allow the Basel Committee to remain open-minded about the risks and the potential impact of this asset class on the financial system.
While the global banking system’s direct exposures to crypto assets 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 crypto assets. Despite the significant progress that the crypto asset market has made, the lack of regulation and capacity of regulators to keep up with rapid developments in the industry is still cause for concern as the market wishes to see regulations expanded beyond the current scope to set a fair framework while also encouraging innovation.
The move towards greater regulation of the cryptocurrency industry is the general trend in many jurisdictions worldwide as governments and regulators seek to address concerns around potential risks.
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