Basel Committee Second Consultation on the prudential treatment of banks cryptoassets
05 July 2022
05 July 2022
Following their June 2021 consultation (see our briefing on this here), the Basel Committee on Banking Supervision has published a second public consultation on the prudential treatment of banks' exposures to cryptoassets. The second consultation builds on the proposals contained in the first consultation whilst introducing certain significant clarifications and amendments.
Following industry feedback, the Committee is considering changes including:
As with the first consultation, there is no detail in relation the treatment of central bank digital currencies - the Committee states that it will be giving further consideration to the treatment of these as and when they are issued.
The consultation builds on the proposals made in the June 2021 consultation and factors concerns and submissions from industry respondents.
It maintains the broad structure of the June 2021 consultation, with cryptoassets divided into two groups:
A specific standards text for cryptoassets exposures (SCO60) has been published to be included, once finalised, in the Basel Framework. The text sets out the Committee's proposals for classifying and treating cryptoassets under the prudential framework.
The second consultation includes a revised stabilisation test for Group 1b (stablecoins) and other refinements to the classification conditions set out in the first consultation, which provide further detail and clarification on the classification of cryptoassets..
The Committee had originally proposed a quantitative test, requiring that banks need to monitor the difference between the market value of the cryptoasset and the market value of the traditional asset 'pegged' on a daily basis and that this difference should not exceed 10 basis points on more than three occasions over any given year. Under the revised proposals, a stablecoin in Group 1b, would need to meet two tests:
The basis risk test retains the same threshold proposed under the original quantitative test (the 10 basis points difference threshold) but with a "second threshold" (set at 20 basis points more than 10 times over any given year) to reduce cliff effects. The Committee is proposing that where a stablecoin meets all the criteria for inclusion in Group 1b but only narrowly passes the basis risk test, it would be subject to an add-on to risk weighted assets rather than be automatically classified as a Group 2 cryptoasset.
The Committee is also considering an alternative to the basis risk and redemption risk test that would recognise that banks' exposures to stablecoins issued by regulated entities, and in particular banks, are generally lower risk than those issued by unregulated entities.
Stablecoins referencing other cryptoassets and algorithmic stablecoins are expressly excluded from Group 1b.
Only group 1a cryptoassets are eligible for recognition as eligible collateral for risk mitigation purposes.
The Committee comments that cryptoassets underpinned by permissionless blockchains would, under current specification, be highly unlikely to fit the criteria set out in Group 1. It is seeking feedback in relation to possible amendments to the classification conditions that would be required to permit the inclusion in Group 1 of cryptoassets that use permissionless blockchains.
The Committee is proposing to introduce an 'add-on' to risk weighted assets to cover DLT infrastructure risks relating to Group 1 cryptoassets. The Committee notes that the infrastructure underlying cryptoassets is still relatively new, and may pose additional, unknown, risks as a consequence. As a result, the following add-ons are proposed for the risk weighting of Group 1 assets:
Following from strongly advocated submissions, the Committee is minded to recognise the risk-reduction effect of hedging transactions with respect to certain Group 2 cryptoassets. In doing so, the Committee is acknowledging the risk-reducing benefits that hedging on highly liquid cryptoassets like bitcoin can bring. The consultation proposes new 'Group 2a assets which meet the hedge recognition criteria, meaning that adapted, and less punitive, market risk rules apply to these assets (and related derivatives), with netting and a 100 per cent capital charge applying. The Committee has however maintained its view that only the simplified/standardised approach to market risk should be relevant to Group 2 cryptoassets, thus assimilating cryptoassets in this category with commodities. The Committee maintained its view that only Group 1 cryptoassets are eligible for being included in an Internal Model for calculating market risk.
The Committee had proposed in the June 2021 consultation that cryptoassets classified as intangibles under relevant accounting standards would be deducted from Common Equity Tier 1 (CET1) along with other intangible assets such as goodwill. The Committee has changed its approach and is now proposing that the prudential treatment should be delinked from the intangible accounting classification.
The consultation clarifies the operational risk and resilience proposal from the first consultation in order to delineate more clearly the risks covered under the operational risk framework and those captured in the credit and market risk frameworks, given concerns that were raised by respondents in this area.
Additional detail is proposed on the application of liquidity risk requirements as follows:
The Committee is proposing to introduce a total exposure limit for all Group 2 cryptoassets outside of the large exposure rules given the lack of a 'counterparty risk' components shared by many Group 2 cryptoassets. A provisional limit will be set at 1 per cent Tier 1 capital to be reviewed periodically. The limit applies to the aggregate amount of all Group 2 cryptoassets on gross exposure basis with no netting or recognition of diversification benefits; measurement of derivative exposures will be done through a delta-equivalent methodology.
Despite clarifying a number of the questions raised by the first consultation and making a number of important improvements for Group 2 cryptoassets, the proposals continue to take a distinctly conservative line with respect to the prudential treatment of unbacked cryptoassets and stablecoins.
Whilst stablecoin treatment has been modified to prevent a 'cliff effect' in classification, the eligibility criteria has hardened further to a degree that makes us sceptical that many (or any) current stablecoins in circulation could be eligible for inclusion as Group 1b.
The Committee wrestle with permissionless blockchain networks appears to us to be stemming from a misconception about the operation and risks posed by such networks. It appears to conflate KYC concerns around the constituent members in the relevant network involved in the validation process and any potential 'whitelisted pockets' that can be monitored effectively by a 'sponsor' or 'originator'. We believe that the Committee can be persuaded through advocacy to soften its position within set parameters.
We continue to see a significant opportunity for banks to issue stablecoins that would be eligible as Group 1b cryptoassets, subject to significantly diluted eligibility criteria relative to non-bank issuers.
The 'infrastructure add on' surcharge looks unnecessary and would be more appropriately captured in operational risk which banks are well versed with in their ordinary course of business when engaging with new technology and infrastructure. In any event, the scale of cryptoassets adoption is such that the Committee will have opportunities to intervene during the scaling up process.
The consultation is open until 30 September 2022 and responses can be submitted here..