BCBS Prudential Treatment of Cryptoasset Exposures: A Guide to Prudential Standards

The Prudential treatment of cryptoasset exposures is a crucial aspect of ensuring the stability of the financial system. According to the BCBS, cryptoassets are considered to be a type of exposure that requires specific prudential treatment.

In the Basel III framework, cryptoassets are classified as level 1 assets, which means they are considered to have the lowest credit risk. This classification is based on the fact that cryptoassets are not backed by any central authority or government.

BCBS also requires banks to hold a minimum capital requirement of 1.5% of the value of their cryptoasset exposures. This requirement is aimed at ensuring that banks have sufficient capital to absorb potential losses from cryptoasset holdings.

Crypto assets are subject to an 800% risk weighting requirement, which applies to both credit and market risks, and covers all types of crypto assets.

This requirement is applied to crypto assets held on a bank's trading or banking book, and is not dependent on the individual characteristics and risk profile of the assets.

Banks must add 800% of the crypto assets they hold to their risk-weighted assets, which is a crucial factor in determining their capital requirements.

A bank must notify FINMA if the amount of crypto assets held on their trading book exceeds 4% of their total capital.

The capital treatment of crypto assets depends on various factors, including whether they are held for trading or custody purposes, and whether they can be segregated in case of an insolvency of the bank.

Here are some specific scenarios that trigger capital requirements:

The BCBS Standard introduces a prudential standard for the treatment of crypto asset exposures, which requires banks to assess and allocate these exposures to either Group 1 or Group 2.

Banks are required to put in place risk management policies, procedures, governance, human, and IT capacities to evaluate the risks of engaging in digital assets.

The BCBS Standard provides for different risk weights and capital requirements based on the underlying asset, features, and risks inherent to a digital asset.

Until today, FINMA has attributed a 800% risk weighting to crypto assets, which covers both credit and market risks and applies to any type of crypto asset.

Banks must add 800% of the crypto assets they hold to their risk-weighted assets, irrespective of whether the assets are held in the trading or banking book and their individual characteristics and risk profile.

Banks must also notify FINMA if the amount of crypto assets held on their trading book exceeds 4% of their total capital.

The Group 2 Digital Assets consist of Tokenized Traditional Assets and Stablecoins that do not satisfy the Classification Conditions and unbacked Crypto Assets.

For Digital Assets that provide for a hedging arrangement that satisfies the applicable hedging recognition criteria, the BCBS Standard sets out adapted market risk exposure rules with an additional 100% capital charge.

For Group 2 Digital Assets that do not provide for a sufficient hedging arrangement, banks will ultimately be required to apply a 1250% risk weighting for the calibration of the applicable capital requirements under the Basel Framework.

A bank's total exposure to Group 2 Digital Assets should not exceed 2% of the bank's total Tier 1 capital and should generally be lower than 1% of the bank's total Tier 1 capital.

The BCBS Standard has classified cryptoassets into two main groups: Group 1 and Group 2. Group 1 cryptoassets are considered low-risk and are subject to equivalent capital requirements based on the risk weights of underlying exposures. Group 1 assets must fully satisfy a set of rigorous Classification Conditions.

Tokenised traditional assets are generally treated like their traditional counterparts, subject to a potential add-on for infrastructure risk on a discretionary basis. Only Group 1a cryptoassets are eligible for recognition as collateral for risk mitigation purposes.

Group 1b cryptoassets, which are stablecoins with effective stabilisation mechanisms, are subject to a 'redemption risk assessment' and a 'supervision/regulation requirement'. This means that only stablecoins issued by supervised and regulated entities are eligible for inclusion.

Stablecoins issued by supervised and regulated entities are eligible for inclusion in Group 1b, but algorithm-based stablecoins or those stablecoins that use automated protocols to maintain their value are excluded from Group 1.

Group 2 cryptoassets are considered higher-risk and are subject to more conservative prudential treatment. They include tokenised traditional assets and stablecoins that fail to satisfy the Group 1 criteria, as well as unbacked cryptoassets.

Group 2 cryptoassets are sub-divided into two categories: Group 2a and Group 2b. Group 2a cryptoassets permit a limited degree of hedging to be recognised based on a 'hedging recognition criteria'. Group 2b cryptoassets are deemed of highest risk and hedging is not recognised.

Here's a summary of the Group 2 sub-categories:

Banks' exposures to Group 2 cryptoassets should generally not exceed 1% of their Tier 1 capital. If the exposure limit is exceeded, Group 2b capital treatment will apply to the amount by which the limit is exceeded.