US Fed, regulators jointly warn banks about liquidity risks from cryptocurrencies

of the board of governors federal Reserve System (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) (collectively, the Agencies) issued a statement regarding the liquidity risks presented by certain sources of funding from crypto-assets. related entities, and some effective practices for managing such risks.

In the statement, the regulators reminded banking For organizations to apply existing risk management principles—meaning it does not create new risk management principles.

However, banking organizations are neither prohibited nor discouraged from providing banking services to any specified class or type of customers as permitted by law or regulation.

Jointly, the regulators highlighted the key liquidity risks associated with crypto-assets and crypto-asset sector participants that banks should be aware of.

Firstly, it shall be deposited by a crypto-asset-related entity for the benefit of the clients (end customers) of the crypto-asset-related entity.

The stability of such deposits, the regulators said, may be driven by the behavior of the end customer or the dynamics of the crypto-asset sector, and not just by the crypto-asset-related entity itself, which is the banking organization’s direct counterparty.

In addition, the stability of deposits may be affected by, for example periods of stress, market volatility, and related vulnerabilities in the crypto-asset sector — which may be specific to the crypto-asset-related entity It may or may not happen.

“Such deposits may be susceptible to large and rapid inflows as well as outflows as end customers react to market events, media reports and uncertainty relating to the crypto-asset-sector,” the regulators said.

Furthermore, he added, this uncertainty and resulting deposit volatility may perpetuate end-client confusion related to false or misleading representations of deposit insurance by a crypto-asset-related entity.

The second would be the deposits that constitute the reserves relating to the stablecoin. According to regulators, the stability of such deposits can be linked to the demand for stablecoins, the trust of stablecoin holders in the stablecoin system, and the reserve management practices of the stablecoin issuer.

To this, he added, “Such deposits may be susceptible to large and rapid outflows caused by, for example, unexpected stablecoin redemptions or dislocations in crypto-asset markets.”

In a broad spectrum, the regulators also said, when a banking organization’s deposit funding base is concentrated in crypto-asset-related entities that are highly interconnected or share similar risk profiles, deposit volatility can also increase. may be correlated, and liquidity risk may therefore be further increased.

Therefore, the regulator directs banks to actively monitor the liquidity risks inherent in such funding sources and establish and maintain effective risk management and controls commensurate with the level of liquidity risks from such funding sources.

Some of the practices that banks can use as per the regulators are:

– Understanding the direct and indirect drivers of the potential behavior of deposits from crypto-asset-related entities and the extent to which those deposits are susceptible to unexpected volatility.

– Assessing potential concentration or correlation in deposits from crypto-asset-related entities and associated liquidity risks.

Incorporating the liquidity risk or funding volatility associated with crypto-asset-related deposits into the contingency fund plan, including liquidity stress testing and, as appropriate, other asset-liability governance and risk management procedures.

– Conducting robust due diligence and ongoing monitoring of crypto-asset-related entities setting up deposit accounts, including assessing representations made by those crypto-asset-related entities to their end customers regarding such deposit accounts, Which can escalate quickly if it goes wrong. Outflow of such deposits.

Lastly, the regulators asked the banks to comply with the applicable laws and regulations.

The year 2022 has gone down in history with bitter shocks for crypto markets, including major stablecoins, illiquidity, bankruptcy of major crypto exchanges, free fall in trading volumes, and extreme volatility among others. The latest bankruptcy that has rocked the crypto market would be that of FTX Group.