Basel Committee Consultation: A Prudential Treatment of Banks’ Cryptoasset Exposure (July 2021)

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Foreword: METI Advisory wrote this report for SEBA Bank AG. Abstract: The Basel Committee on Banking Supervision (BCBS) commenced in June 2021 the consultation on the ‘Prudential treatment of cryptoasset exposures’ document as an initial step towards the promulgation of the internationally binding capital and liquidity rules applicable to banks’ exposure to cryptoassets. Building on a discussion paper issued in December 2019, this consultation document introduces the distinction between tokenised traditional assets and non-algorithmic stablecoins and other cryptoassets, such as bitcoin, ether, utility tokens, DeFi tokens, and other network tokens, as well as algorithmic and crypto-backed stablecoins. The ‘Pillar 1’ formulaic minimum capital charge for banks’ exposure to tokenised traditional assets should be at least equivalent to those of traditional assets. However, the exposure to non-algorithmic stablecoins should be subject to new, dedicated Pillar 1 guidance. Other cryptoassets (e.g. bitcoin, ether, utility tokens, DeFi tokens, and other network coins), as well as algorithmic and crypto-backed stablecoins, should be subject to the one-size-fits-all, harshest possible Pillar 1 charge (1,250% risk-weight) corresponding to the full exposure deduction from the capital base. The BCBS plans to supplement the Pillar 1 minimum charge with an operational risk add-on, as well as provide additional guidance under Pillar 2 (supervisory review process) and Pillar 3 (disclosure), and extend the current leverage ratio, large exposures, and liquidity ratio frameworks to cryptoassets. While the consultation paper recognises the ineluctability of asset tokenisation and stablecoins, it disappoints by continuing to apply the one-size-fits-all, harshest possible capital charge to the exposure to all cryptoassets other than tokenised traditional financial assets and non-algorithmic stablecoins. From a risk viewpoint, this approach assimilates diverse cryptoassets such as bitcoin, ether, utility tokens, DeFi tokens, and other network coins, as well as algorithmic and crypto-backed stablecoins, to a single asset, akin to the worst externally rated traditional securitisation tranches. It thus evidences a poor understanding of the natures of these diverse cryptoassets. The BCBS recognises that the specification of final rules will likely require more than one consultation. Further, it is important that this process includes the know-how of the cryptoindustry, which typically resides outside the scopes of BCBS-regulated entities. As such, it can lead to a deeper understanding of cryptoassets and the recognition of the diversity of their economic functions, governance arrangements, and risk profiles. However, an implementation of the proposed blunt approach would likely stifle innovation and promote parallel, unregulated cryptoasset activities.