The Basel Committee on Banking Supervision’s (BCBS) new global standard for the prudential treatment of crypto assets, given the increased capital requirements, may deter banks from granting loans backed by riskier crypto assets that have led to waves of contagion within the broader crypto ecosystem, Fitch Ratings says. However, repo-style transactions will receive some beneficial collateral recognition that may increase banks intermediation of crypto financing transactions with wholesale counterparties.
 
Over time the new regime will support internationally-active banks’ asset tokenisation and stablecoin efforts, by harmonizing supervisor’s approaches to these nascent asset classes by latest 2025. Once the standard is implemented into national legislation, it will likely encourage more banks to test the waters regarding the issuance and holding of tokenized assets, including fractional ownership instruments.
 
The finalized rules divide digital assets into two groups. For the first time the standard defines minimum prudential and capital requirements for Group 1 assets, which include stablecoins and tokenized traditional assets issued through distributed ledger technologies. Group 1 asset capital requirements are based on looking-through to the capital treatment of the underlying assets, plus an infrastructure risk capital add-on that individual regulators can determine.
 
Group 2 assets, such as riskier Bitcoin, Ether and tokens and stablecoins that don't qualify as Group 1 assets, are subject to a conservative capital treatment, where the net position is effectively deducted from a bank’s capital base. Aggregated Group 2 holdings must not exceed 2% of a bank’s Tier 1 capital. Crypto assets held on a custody-only basis will not be subject to prudential requirements.
 
Stablecoins have to comply with strict classification requirements to be treated by banks as Group 1 assets, which Fitch believes will improve stability and reduce systemic risks, while forcing an improvement in issuers’ risk management, governance, and transparency standards. The Basel criteria allow only the highest-quality government securities or cash as stablecoin reserve assets, comprehensive legal token redemption, with governance requirements around reserve management.
 
With the exception of eligible financial collateral in a tokenized format, crypto assets, including stablecoins, will not be recognized as eligible collateral to reduce capital requirements on loans backed by cryptos, or on derivatives. This will increase the capital carry associated with loans backed by crypto collateral under the standardized non-modelled approaches to credit and counterparty credit risk. It will also present more legal and operational uncertainty versus conventional financial collateral, if banks use internal loss-given default credit models. However, for repo-style transaction involving cryptos, crypto assets of all kinds can be recognized as risk-reducing, subject to a 25% haircut.
 
Currently, links between crypto markets and regulated financial markets remain weak. However, by increasing the likelihood of banks’ intermediation of crypto-related clearing, client and market-making services, or securities financing and repo-style transactions, the financial links between crypto and conventional markets is likely to increase. As of end-2021, a handful of large banks had in aggregate just €9.4 billion (US$9 billion, or 0.01% of sampled balance sheet assets) in crypto asset exposure, according to the Bank of International Settlements.
 
However, the penal capital treatment, including conservative limits, will strongly discourage banks from taking net directional risk on riskier Group 2 cryptos. Similarly, elevated legal (including money laundering), operational and cybersecurity requirements may deter banks from offering loans or securities financing transactions backed by crypto. Were such collateral seized and held on-balance sheet, this could push up banks risk-weighted asset capital requirements.