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Regulators Have Proposed Capital Rules at Banks for Crypto Assets. Here's How It Would Work

By Bram Berkowitz - Jun 20, 2021 at 7:32AM

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The Basel Committee on Banking Supervision's proposed regulation would have banks hold different levels of capital for different types of crypto assets.

The Basel Committee on Banking Supervision (BCBS), a global forum of central banks and regulators that essentially sets the pace for banking regulation around the world, just released a proposal for how regulators should require banks to treat crypto assets. If passed, the proposal could have far-ranging implications for how willing banks are to hold crypto assets. Let's take a look at what BCBS is proposing.

Capital requirements for crypto assets

Currently, most banks don't have a ton of exposure to crypto assets, but soon enough, many banks may allow customers to buy, sell, and hold cryptocurrencies like bitcoin (BTC -0.17%) as demand for crypto has surged. One of the big parts of bank regulation is how much capital banks have to set aside for certain assets such as loans in order to prepare for potential losses. The main part of what BCBS is trying to do is determine an appropriate amount of capital that banks need to hold to account for potential losses they may face on crypto assets.

The first piece of BCBS's proposal is splitting different crypto assets into three different groups -- 1a, 1b, and 2 -- which will have different forms of regulation. 1a crypto assets are tokenized traditional assets, which are just like real assets such as real estate or art that are represented by digital tokens that can be issued on a blockchain network. 1b crypto assets are basically stablecoins, cryptocurrencies that are attached to another, ideally more stable asset such as the U.S. dollar or maybe a commodity like gold. Lastly, group 2 crypto assets are cryptocurrencies like bitcoin and Ethereum (ETH -1.19%), which have been extremely volatile.

A gold and turquoise circle with a Bitcoin symbol in the middle.

Image source: Getty Images.

Banks calculate the capital they need to hold for potential loans losses by taking the value of the asset, multiplying by the risk-weight percentage of that specific asset, and then typically multiplying that number by the bank's target capital requirement percentage (usually 8% to 12% these days). So to make things simple, let's say you have a $100 commercial loan with a risk weight of 150%, and the bank's minimum capital requirement is 8%. The bank would need to have $12 in reserves to support the loan ($100 x 1.5 x .08).

BCBS is proposing for 1a tokenized assets to have similar capital requirements to those of traditional bank assets with the potential for capital add-ons. But for group 2 crypto assets, which are riskier, BCBS is dropping the hammer by requiring banks to assign a risk weighting of 1,250%. To provide some comparison, a standard residential mortgage, which is not considered to be a very risky type of loan, may get a risk-weighted percentage of 50%. The 1,250% rating essentially means that for every $100 of bitcoin or Ethereum exposure a bank has on its balance sheet, it will need to set aside $100 in capital ($100 x 12.5 x .08).

The proposal for 1b stablecoins is not as harsh as for crypto assets like bitcoin but not as lenient as for tokenized assets. BCBS is proposing a risk weight for stablecoins that incorporates the asset that the stablecoin is pegged to plus the risk weight of an unsecured loan, which might be 100% or more, so it's certainly not insignificant. One other aspect of the BCBS proposal is that it does not plan to let any crypto assets qualify as eligible high-quality liquid assets (HQLA), which factor into certain regulatory ratios banks must abide by, such as the leverage ratio and liquidity coverage ratio. This is interesting because most crypto assets are considered to be highly liquid, so it would make sense for BCBS to consider allowing 1a or 1b crypto assets to count as HQLA, although BCBS did say it would continue to further investigate the matter.

Final takeaway

With such a high bar of capital required to hold crypto assets on the balance sheet, BCBS' proposal would very likely discourage banks from doing things like deploying excess liquidity into crypto assets like bitcoin and holding it on their balance sheet. Still, I don't think the regulation would prevent banks from serving as custodians for clients' crypto assets and conducting payments activities for crypto clients.

Also, bitcoin seemed to shake off the announcement of the potential regulations with its price gaining on the news. Many saw BCBS' attention to the matter as proof that cryptocurrencies will be a part of the larger financial system. But ultimately, the proposal issued by BCBS is still preliminary, and the organization is now seeking feedback from stakeholders. It could very well change and take a good deal of time to implement, but it's certainly something to keep an eye on.

Bram Berkowitz owns shares of Bitcoin and Ethereum. The Motley Fool owns shares of and recommends Bitcoin. The Motley Fool has a disclosure policy.

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