In a remarkable change considering the current state of modern finance, crypto-assets have been categorized as a distinct risk by U.S. federal bank regulatory agencies.
Their preliminary warning devoted to financial institutions engaged in crypto activities was published on January 3, 2023, by the Office of the Comptroller of the Currency (OCC), the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC).
In synchrony with other regulators, it reflects a concern regarding the safety and soundness of the banking system along with its rapid advancements in technology.
US regulators have issued their first ever joint warning to banks over the risks associated with the cryptocurrency marke
As part of a global effort to warn banks about the risks associated with the crypto world, American regulators have for the very first time jointly warned banks regarding the threats associated with cryptocurrency.
The institutions made two things clear- corporations dealing with issues of digital assets and other related services have vague and questionable liquid structures and there are significant risks of deceitful marketing by such companies.
The peril of ‘contagion’ – where the problems in the crypto domain may diffuse into traditional finance institutions – was also noted.
This alert comes two months after the devastating collapse of the FTX exchange that affected the entire crypto industry.
The Federal Reserve together with the Federal Deposit Insurance Corporation (FDIC) released the advisory stating that they are monitoring the relations of the banks which are incorporating crypto assets within their services.
Key Risks Identified
A few specific risks that banking organizations could face while dealing with crypto-assets are mentioned in their joint statement: banking organizations’ risks.
Fraud and Scams: The crypto-asset realm has seen many instances of fraud and scams, costing a lot to investors and institutions.
Legal Uncertainty: Legal disputes over jurisdiction and classification remain a raging issue for crypto-assets in bank framework. This uncertainty is bound to create compliance headaches for the banks.
Misleading Disclosures: Deficient disclosure policies on the part of some crypto-asset companies make these firms vulnerable to being perceived as misleading, thus failing basic standards of corporate social responsibility.
Volatility: Known for their price volatility, crypto-assets can pose severe financial exposure and risk of instability to the institutions underwriting, holding, or trading these assets.
Contagion Risk: The crypto market’s interwoven structure means that a failure or serious problem from one entity does have tentacles that reach out to others and can suck the wider financial system under.
Regulatory Approach and Considerations
At this stage, the agencies adopted a “guarded and cautious position” on crypto-related activities and exposures at banking institutions. They are evaluating whether or not these activities can be undertaken safely, soundly, lawfully, and in compliance with regulations, including those concerning consumer protection.
Recommended Actions
Encourage Active Engagement in Supervisory Dialogues: Prior to commencing or increasing any crypto-asset related activities, banks should proactively engage their supervisory office to discuss the identified risks and understanding of regulatory expectations, in order to formulate a strategy that does not entail regulatory friction.
Develop Comprehensive Risk Management Policies: Institutions should implement policies to manage risks related to, but not limited to, crypto-assets, fraud, legal admission, and volatility.
Employ Compliance with Laws and Regulations: Banks have the responsibility to ensure that all processes and procedures involved in crypto-asset dealings do not breach – directly and indirectly – laws including but not limited to, consumer protection regulations, anti-money laundering rules, and other relevant legislations.
Consequences for the Banking Industry
This joint statement marks the particular point in time where U.S. regulators have commenced closely monitoring the assimilation of crypto-assets into the traditional banking framework.
Although the agencies are not stopping banks from interfacing with crypto assets, they have set a very weak framework around the risks and compliance.
This controlled stance takes into account the possibility of hitting systemic risks while trying to mitigate other discovered cons in an otherwise highly innovative and volatile sector.
As suggested, the agencies will continue to keep an eye on the banking organization’s exposure to crypto assets and may have more statements to issue as they see fit.
This also suggests that the crypto asset domain, as it is now called will continue to evolve alongside the regulators tending to the policies on its relationship with the banking sector.
FTX Shock
The inauguration of FTX marked a glorious entry point into the cryptocurrency world for many. With its sudden growth, it became the second largest exchange globally. This all came crashing down in November when it was declared bankrupt, leading to chaos for millions.
In a U.S court appearance this week, Bankman-Fried pleaded not guilty to scamming his customers and investors. The prosecution alleges that he misappropriated customer assets to fund his trading firm, Alameda Research, alongside hefty property purchases and illegally funding political candidates.
This has sparked national outcry after two of his accomplices turned stalwart witnesses and began aiding with the ongoing investigation.
Alongside the outrage, multiple shocked faces emerged as Bankman Fried turned out to be the backbone of numerous failing crypto businesses. His ties to politics, coupled with the celebrity endorsements further drew everyone in, validating their investments in his ventures, making his undoing all the more shocking, claiming ‘This is all built on lies’.
