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Banks ask for space to grow crypto as regulators ponder guardrails

The nation’s largest banks are asking an international body of regulators to give them the space to grow their crypto asset exposures, sparking debate over where guardrails should be placed on the emerging asset class.

On Tuesday, an advocacy group representing the eight largest U.S.-based financial institutions wrote to the Bank of International Settlements (BIS) regarding its proposal for a global framework for bank exposure to crypto assets.

“We find the proposals in the consultation to be so overly conservative and simplistic that they, in effect, would preclude bank involvement in crypto asset markets,” the Financial Services Forum wrote.

The BIS’s Basel Committee, the world’s primary standard setter for bank regulatory rules, published a proposal framework in June that would delineate assets like stablecoins from more speculative assets like bitcoin. The committee, which flagged “financial stability concerns” in the crypto space, proposes different regulatory approaches based on which type of crypto assets a bank has exposure to.

The FSF (which represents Bank of America, BNY Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo) urged the BIS to lighten the framework’s more stringent approach to riskier crypto assets.

The banks say the BIS should encourage banks to deepen their involvement in the crypto space, since it would bring the emerging asset class into the “clear line-of-sight” of banking regulators.

U.S. bank regulators have largely deferred to the BIS with regard to any approach, but Securities and Exchange Commission Chair Gary Gensler said Tuesday that riskier crypto assets should be treated as such.

“To hold appropriate capital, if it's on a bank's balance sheet, would seem to fit into the remit that we've had in the past: that there be appropriate shock absorbers against a potential loss,” Gensler said at a Washington Post event.

The SEC is not a primary banking regulator; any Basel rules would be implemented in the U.S. by the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp.

Risk weights

Under the BIS proposal, cryptocurrencies that are not a tokenized version of a traditional asset or lack a “stabilization mechanism” on its value would broadly be categorized as a “Group 2” asset that comes with “additional and higher risks.”

Stablecoins, for example, would likely not be classified as Group 2. Bitcoin would.

The Basel Committee would slap those Group 2 assets with a 1,250% risk weight when calculating a bank’s capital levels (a key measure of a firm’s health calculated as its assets minus its liabilities).

Higher risk weights require a bank to hold more capital against those holdings to insulate the firm’s depositors from any losses that may come from holding those assets.

“In other words, the capital will be sufficient to absorb a full write-off of the crypto asset exposures without exposing depositors and other senior creditors of the banks to a loss,” the Basel Committee wrote in its proposal.

At 1,250%, the risk weight for crypto assets would be far above those for residential mortgages (generally between 50%-100%) or junk-rated corporate bonds (generally 100%).

The banking industry wrote that the world of crypto assets is too diverse to apply one risk weight across the entire category, adding that the regulatory framework should also account for any hedges made by the bank.

“If...the prudential framework for crypto assets is too punitive for bank involvement in this market, competition may be stifled,” the FSF comment letter reads.

The BIS stopped taking public comments on its proposal earlier in the month but committed itself to “an iterative process” that would involve rounds of consultation as the framework is put together.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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