EU awards highest risk weight for crypto assets

European lawmakers are forcing the bloc’s financial institutions to play with cryptocurrencies.

This comes as the European Parliament’s Committee on Economic and Monetary Affairs voted in a cross-party compromise on Tuesday (January 24) to impose tough new requirements on banks doing or facilitating transactions in crypto assets.

The requirements include a provision that bank holdings of unhedged crypto should receive the highest possible risk weighting and recommend that volatile digital assets are also further limited as a proportion of a bank’s total issuance of core financial instruments.

The main recommended requirement is a transitional treatment to apply a 1,250% risk weight to crypto assets by December 31, 2024. The risk weight means that financial institutions must hold enough capital in reserve to cover and protect themselves against a total loss of a crypto asset protect value to buy and do business with.

The higher an investment’s risk weight, the more capital a bank must hold in order to meet capital adequacy requirements – the figure is determined by dividing the bank’s capital by its risk-weighted assets.

The provisions come as part of a broader effort to bring European Union (EU) regulations in line with banking standards proposed by the Basel Committee on Banking Supervision, a group of regulators and central bankers from around the world and an international standard-setter for the industry became.

The Basel Banking Committee’s proposal for 2022 has already been approved by the Group of Central Bank Governors and Heads of Supervision (GHOS), with a successful vote in December last year.

Continue reading: European Commissioner: Crypto rules needed worldwide

The Basel Committee’s “Prudential Treatment of Cryptoasset Exposures,” part of the so-called Basel III Global Accord, suggests that banks need to treat crypto with caution. It recommends that exposure to certain cryptocurrency assets should not exceed 2% and should generally be less than 1% of Tier 1 capital – a core class of financial instruments that is widely regarded as a measure of an institution’s resilience.

“As a result of the classification requirements, crypto assets must be designed to be redeemable for a predefined amount of a reference asset or assets or cash equal to the value of the reference asset(s),” recommends the Basel Committee document, adding, “About In addition, the crypto-asset arrangement must include a sufficient pool of currency reserves to ensure that the repayment claims of crypto-asset holders can be met, and banks that have banking book exposures to crypto-assets must analyze their specific structures and identify any risks, which could result in a loss. Each credit risk has to be capitalized separately by the banks according to the credit risk standards.”

The new EU requirements reflect this recommendation. After approval by the European Parliament, the measures will have to be negotiated separately with the national finance ministers of the bloc’s member states, who are meeting in the Council of the EU as part of a broader, bundled package of upcoming bank capital reforms.

The requirements are seen as interim measures designed to encourage banks to hold sufficient capital to deal with crypto market shocks without having to resort to taxpayer-funded national liquidity solutions and to prevent crypto market instability from escalating encroaches on the traditional financial system.

The EU plans to release a report in June 2023 detailing its findings over the next six months and proposing broader rules for banks working with crypto to be implemented in 2025.

“Today’s agreement is an important step towards completing the EU’s implementation of international Basel III reforms,” ​​Caroline Liesegang, head of Prudential Regulation at the Association for Financial Markets in Europe (AFME), a lobby group representing traditional financial organizations such as investments Banks said in a public response to the news.

“More work is needed on the crypto-assets proposal to better define its scope to ensure that tokenized securities are not covered,” she added, drawing attention to the fact that the scope of the requirements relating to Crypto may be too broad and also applies to tokenized securities, not just cryptocurrency assets.

The Basel-recommended cap on banks’ crypto exposure has already been pushed back by a consortium of a dozen industry groups, including the Global Financial Markets Association and the Institute for International Finance, among others.

Collectively, the groups indicated that as an impact of the requirements, “it may not be economically viable and rational [for banks] to make the necessary investments to meet the needs of clients in relation to activities related to crypto assets. As a result, banks would be limited in their ability to respond to their customers’ demands for access to cryptoasset products and services. This outcome is not in the best interests of customers, investors or the broader financial system and would likely result in a shift of activity in this area to the non-banking sector,” the public letter reads.

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