US agencies recommend old risk management principles for crypto liquidity

Published at: Feb. 25, 2023

In a joint statement released by three United States federal agencies, the banking sector was advised against creating new risk management principles to counter liquidity risks resulting from crypto-asset market vulnerabilities.

The Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) released a statement reminding banks to apply existing risk management principles when addressing crypto-related liquidity risks.

The joint statement highlighted the key liquidity risks associated with crypto-assets and related participants for banking organizations. The risks highlighted concern the unpredictable scale and timing of deposit inflows and outflows.

In other words, 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.

The federal agencies specifically highlighted two instances to showcase the liquidity risks associated with cryptocurrencies:

Deposits placed by a crypto-asset-related entity for the benefit of the crypto-asset-related entity’s customers (end customers). Deposits that constitute stablecoin-related reserves.

In the first instance, the price stability depends on the investors’ behavior, which can be influenced by “stress, market volatility and related vulnerabilities in the crypto-asset sector.” The second type of risk is related to the demand for stablecoins. The joint statement read:

“Such deposits can be susceptible to large and rapid outflows stemming from, for example, unanticipated stablecoin redemptions or dislocations in crypto-asset markets.”

While the trio agreed that “banking organizations are neither prohibited nor discouraged from providing banking services” as per the law of the land, it recommended active monitoring of the liquidity risks and establishing and maintaining effective risk management and controls over crypto offerings.

The agencies recommended four key practices for effective risk management to banks, which include 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.

Related: Approach with caution: US banking regulator’s crypto warning

On Jan. 3, the same three federal agencies — the Fed, FDIC and OCC — issued a joint statement highlighting eight risks in the cryptosystem, including fraud, volatility, contagion and similar issues.

The agencies jointly stated:

“It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system.”

The statement highlighted the possibility of changing crypto regulations with references to agencies’ “case-by-case approaches to date.”

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