June 11, 2021

Bitcoin put in highest risk category in global bank capital plan

By ellen

GENEVA (BLOOMBERG) – Global banking regulators have moved to classify Bitcoin as the riskiest of assets, dragging cryptocurrencies further into the mainstream financial world.

But they also made it extremely costly for banks to hold digital tokens on their balance sheets, potentially delaying crypto’s wider adoption.

The Basel Committee on Banking Supervision proposed on Thursday (June 10) that a 1,250 per cent risk weight be applied to a bank’s exposure to Bitcoin and certain other cryptocurrencies.

Bitcoin jumped about 5 per cent after the announcement before paring the gains.

Mr Luke Sully, chief executive at treasury technology specialist Ledgermatic, said: “It’s a piece of news that both advocates and critics of Bitcoin will declare as a win. It demonstrates that Bitcoin is now a recognised asset class with risk management parameters for the banks, but these same parameters could be a potential deterrent given the onerous capital requirements that may make it an unpalatable business.”

He added: “There are a few underlying assumptions in this risk weighting, the most obvious being that the price may go to zero and investors could lose their full allocation. The capital requirements don’t protect the banks clients from transaction, settlement and FX (foreign exchange) volatility either.”

Banks will face the toughest capital requirements for holdings in Bitcoin and other crypto assets under global regulators’ plans to ward off threats to financial stability from the volatile market.

The Basel Committee said the banking industry faces increased risks from crypto assets because of the potential for money laundering, reputational challenges and wild swings in prices that could lead to defaults.

The proposal of a 1,250 per cent risk weight means that, in practice, a bank may need to hold a dollar in capital for each dollar worth of Bitcoin, based on an 8 per cent minimum capital requirement. Other assets with this highest-possible risk weighting include securitised products where banks have insufficient information about underlying exposures.

“The growth of crypto assets and related services has the potential to raise financial stability concerns and increase risks faced by banks,” the Basel Committee, which includes the Federal Reserve and European Central Bank, said in the report. “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 proposal is open to public comment before it will take effect, and the committee said these initial policies are likely to change several times as the market evolves. No timeline was specified in the report but the process for agreeing and implementing Basel rules worldwide can typically take years.

Some assets, such as tokens with values tied to real-world assets and stablecoins, are set for lower capital requirements.

Crypto has exploded in popularity this year, with day traders and professionals alike hunting for profits in Bitcoin, as well as the more obscure niches of the market. Enthusiasm about institutional adoption, the idea that it is a store of value akin to “digital gold”, and endorsements from big-name investors like Paul Tudor Jones and Stan Druckenmiller have all fanned the bull market.

Bitcoin jumped from about US$10,000 last September to as high as US$63,000 in mid-April. However, in the past month, prices have collapsed, falling back to US$37,000, on the back of tougher regulatory scrutiny in China and billionaire Elon Musk’s criticism of Bitcoin’s high energy cost.

“The only consistency has been the volatility – it’s been big spikes, tons of enthusiasm, followed by big sell-offs,” said investment strategy analyst Ross Mayfield from Robert W. Baird & Co, of Bitcoin’s moves.

“If you believe in it you’re probably to stomach the volatility, but if you’re just in it because it seems like the hot way to get a quick buck, that volatility is going to be hard to deal with.”

While many banks have been cautious about jumping into crypto trading, the surge in consumer interest is driving financial firms, including those such as Interactive Brokers Group and Robinhood Markets.