US Regulators Advise Banks on Managing Liquidity Risks in Crypto Market
This article provides an overview of a joint statement advising banks to apply risk management principles in addressing crypto-related risks.
In a joint statement released on February 3, 2023, by the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC), the three US federal agencies urged banks to apply existing risk management principles when dealing with liquidity risks arising from the crypto market.
The statement comes amid growing concerns about the unpredictable scale and timing of deposit inflows and outflows in crypto-asset markets. The federal agencies specifically highlighted two instances to showcase the liquidity risks associated with cryptocurrencies: deposits placed by a crypto-asset-related entity to benefit the crypto-asset-related entity’s customers and deposits that constitute stablecoin-related reserves.
Price stability risks in crypto-asset markets
In the first instance, the price stability of a cryptocurrency depends on investors’ behavior, which can be influenced by stress, market volatility, and related vulnerabilities in the crypto-asset sector.
The federal agencies raised concerns about an event where massive selloffs or purchases would negatively impact the liquidity of the asset, potentially incurring losses for investors.
Stablecoin-related liquidity risks
The second type of risk is related to the demand for stablecoins. The joint statement warns that such deposits can be susceptible to significant and rapid outflows stemming from, for example, unanticipated stablecoin redemptions or dislocations in crypto-asset markets.
Recommendations for effective risk management
While federal agencies recognize that banks are neither prohibited nor discouraged from providing banking services for crypto-related activities, they advise banks to actively monitor liquidity risks and establish and maintain effective risk management and controls over crypto offerings.
The agencies recommended four key practices for effective risk management to banks, including performing robust due diligence and monitoring of crypto assets, incorporating the liquidity risks, assessing interconnectedness between crypto offerings, and understanding the direct and indirect drivers of the potential behavior of deposits.
The joint statement is the second of its kind from the three US federal agencies. On January 3, 2023, the same agencies issued a joint statement highlighting eight risks in the cryptosystem, including fraud, volatility, contagion, and similar issues. The report emphasized that risks related to the crypto-asset sector that cannot be mitigated or controlled should not migrate to the banking system.
Implications for the crypto market
The joint statement by the three US federal agencies could have significant implications for the crypto market, especially for banks providing banking services to crypto-related entities.
The statement sends a clear message that banks must apply existing risk management principles to address liquidity risks arising from the crypto market. The report also highlights the need for banks to actively monitor and assess the risks associated with crypto offerings and establish and maintain effective risk management and controls.