In December 2022, the Bank of International Settlements, through its Committee on Banking Supervision (BCBS), released its standard for the prudential treatment of crypto-asset exposures (BCBS Standard).

While its recommendations are not binding, the BCBS is the primary global standard setter for the prudential regulation of banks. It provides a forum for regular cooperation on banking supervisory matters, and the ECB has taken note.

The ECB and BCBS

In the ECB supervision letter dated 15 February 2023 (accessible here), the ECB seeks to address the possible spillover of crypto-asset risks into the banking sector, and it has agreed with the BCBS that “a conservative global minimum prudential framework” is required to protect from these risks. The ECB points to the BCBS Standard for this framework and notes it has marked an important milestone for protecting against these risks, providing a harmonised regulatory and supervisory approach to banks’ crypto-assets exposures. In highlighting their further acceptance of the BCBS Standard, the ECB notes that the BCBS Standard complements the EU’s Markets in Crypto-Assets Regulation (MiCA) (for an overview on MiCA, please see our recent briefing) and wishes to have the BCBS Standard adopted into EU Legislation by 1 January 2025 (the deadline mentioned within the BCBS standard).

What does the BCBS Standard recommend?

The BCBS Standard suggests different exposure limits depending on what type of crypto-asset is involved. As you can see below, the BCBS Standard divides crypto-assets into either Group 1 or 2, depending on set criteria (largely, it is tokenised and stabilised assets versus those which are not just tokenised or stabilised), but then engages in sub-division of those categories dependant on the assets characteristics and its risk profile.

Group 1 crypto-assets are defined as assets which include tokenised traditional assets (Group 1a) and crypto-assets with stabilisation mechanisms, i.e. stablecoins (Group 1b). To be deemed included within the Group 1 designation, the crypto-asset must meet four classification conditions, such as:

• assigning legally enforceable rights;
• ensuring the underlying network mitigates material risks;
• is addressing certain considerations around money laundering; and
• the soundness of the information and communications technology arrangements.

The benefit of dealing in Group 1 crypto-assets is that they are subject to the same capital requirements that are already set out in the existing Basel Framework, which all banking institutions abide by.

Group 2 crypto-assets are described as those who do not meet the requirements mentioned in the Group 1 list above and include:

• stablecoins that have ineffective stabilisation mechanisms;
• so-called unbacked crypto-assets such as bitcoin and arguably ether; and
• tokenised traditional assets which do not meet the Group 1 requirements.

Group 2 crypto-assets are viewed as posing higher risks and are subject to a capital treatment with a risk weight of 1,250%. This risk weight can be avoided if the Group 2 crypto-assets meet certain hedging criteria, which is classified as Group 2a. Those needing to meet these hedging criteria are referred to as Group 2b.

The risk weight is not the only downside for Group 2 crypto assets, as the BCBS Standard also mandates an exposure limit for those assets. Exposure is measured as the higher of the gross long and gross short position in each crypto asset. The BCBS Standard recommends that banks generally hold just below 1% of Tier 1 capital (i.e. disclosed reserves, common stock, the capital representing the core quality assets) under this exposure limit. If the 1% limit is breached, then the Group 2b treatment will apply to all exposures exceeding 1%, and if the exposure exceeds 2%, then Group 2b treatment applies to all of the Group 2 exposures. This is to incentivise banks to stay within the 1% limit.

What’s next?

As mentioned, the ECB has called for the BCBS Standard to be adopted into EU law before 1 January 2025 and is calling on banks in the meantime to abide by the BCBS Standard.

In attempting to answer this call, the European Parliament’s Economic and Monetary Affairs Committee has invited the European Commission to submit a legislative proposal by June 2023 to address the prudential treatment of crypto-assets, taking into account the BCBS Standard (press release available here), which is part of the proposed changes to the Capital Requirements Regulation and Capital Requirements Directive to account for the well-known “Basel-III” reforms. Given the considerable array of legislation currently before the EU institutions, how quickly this regulation takes shape remains to be seen. Gerry Cross, Director of Financial Regulation, Policy & Risk at the Central Bank of Ireland, at a recent speech at Blockchain Ireland Week, noted that the finalisation of the standard, and the European Commission’s move to incorporate the standards into legislation is “important and welcome” (our article on the speech, focusing on the implementation of MiCA, is available here).

The ECB’s call for further regulation, and for banks to adopt the BCBS Standard, can be seen as an acceptance that crypto-assets are now materially relevant to the mainstream banking sector. Crypto is here to stay and is likely to grow in significance. If you wish to discuss any queries arising from the above, or to get in touch regarding the impact of MiCA and its treatment of crypto-assets, please contact one of our key contacts listed here or your usual William Fry contact.

Contributed by Conor Forde