small>1 The Liquidity Guidance reemphasizes the skepticism
that the federal banking regulators have expressed toward the
crypto-asset sector and may make it even more difficult for
crypto-asset-related entities to open bank accounts.
In this Legal Update, we provide background on liquidity risk
and discuss what the Liquidity Guidance means for banks and the
crypto sector.
Background
Liquidity is a bank’s capacity to meet its cash and
collateral obligations at a reasonable cost.2 Liquidity
risk is the risk that a bank’s financial condition or overall
safety and soundness is adversely affected by an inability (or
perceived inability) to meet its obligations. For some banks, there
are quantitative liquidity risk management requirements, but all
banks are expected to prudently manage their liquidity risk.
Liquidity risk has long been recognized as one of the top-tier
risks that a bank faces.3 However, prior to the 2008
financial crisis, much of the supervisory focus of banking
regulators was on other top-tier risks, such as credit and market
risks. As a consequence of the 2008 financial crisis, regulators
began to focus on liquidity risk as both a regulatory and a
supervisory priority.4
Liquidity Guidance
Crypto-assets are a new and rapidly evolving asset class that
present new risks, as well as old risks in new ways. The Liquidity
Guidance focuses on the liquidity risks presented by certain
sources of funding from crypto-asset-related entities.
Two Situations with Heightened
Risk
In particular, it highlights two situations that the regulators
believe create heightened liquidity risk for banks:
- Deposits placed at a bank by a crypto-asset-related entity
that are for the benefit of the crypto-asset-related entity’s
customers. While brokered and other pass-through deposit
accounts are common (the FDIC recognizes at least 13 types of
brokered deposits5), the regulators believe that
deposits placed by a crypto-asset-related entity present heightened
risk from the combination of the unpredictable behavior of the
crypto-asset-related entity’s customers and the volatility of
crypto-asset sector’s dynamics. This rapid, large-scale conduct
can lead to bank runs where a crypto-asset-related entity’s
customers rapidly deposit or withdraw funds. - Stablecoin deposits. Risk is heightened because the
stability of stablecoin deposits may be linked to the demand for
stablecoins, the confidence of stablecoin holders in the stablecoin
arrangement, and the stablecoin issuer’s reserve management
practices. As with customer deposits, rapid redemption of
stablecoins that are driven by factors exogenous to the bank can
lead to a bank run.
Risk Management
The Liquidity Guidance states that banks should use existing
risk management principles to prudently manage the liquidity risks
of crypto-asset activities. It also provides examples of how banks
might apply four risk management principles to crypto-asset-related
entity customers:
- Understanding the direct and indirect drivers of potential
behavior of deposits from crypto-asset-related entities and the
extent to which those deposits are susceptible to unpredictable
volatility. - Assessing potential concentration or interconnectedness across
deposits from crypto-asset-related entities and the associated
liquidity risks. - Incorporating the liquidity risks or funding volatility
associated with crypto-asset-related deposits into contingency
funding planning, including liquidity stress testing and, as
appropriate, other asset-liability governance and risk management
processes. - Performing robust due diligence and ongoing monitoring of
crypto-asset-related entities that establish deposit accounts,
including assessing the representations made by those
crypto-asset-related entities to their end customers about these
deposit accounts that, if inaccurate, could lead to rapid outflows
of these deposits.
Takeaway
There are few banks engaged in crypto-asset activities of any
type, although presumably more are engaged in banking crypto-asset
entities.6 The Liquidity Guidance may cause these banks
to look more closely at their crypto-asset customers to understand
the liquidity risks presented by their accounts. At a minimum,
these banks should expect greater supervisory scrutiny of these
banking relationships.
The Liquidity Guidance emphasizes that banks are “neither
prohibited nor discouraged from providing banking services to
customers of any specific class or type, as permitted by law or
regulation.” However, there already are public reports of
banks exiting relationships with crypto-asset-related entities.
7 This type of behavior is likely to continue as
banks weigh the cost of regulatory scrutiny and heightened risk
management expectations against the low margins of deposit banking.
Therefore, crypto-asset-related entities should expect to encounter
difficulty in opening and maintaining bank accounts for the
foreseeable future.
Footnotes
1. Press Release, Agencies issue joint statement on
liquidity risks resulting from crypto-asset market
vulnerabilities (Feb. 23, 2023), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20230223a.htm.
2. See OCC, Liquidity Handbook at 3
(Aug. 16, 2021); Federal Reserve, BHC Supervision Manual
§ 1060.20.1 (Feb. 2023).
3. See, e.g., OCC, NR 1996-2 (Jan. 4, 1996);
see also BPI, Is It Time For a Holistic Review of
Liquidity Requirements? (Feb. 23, 2023).
4. E.g., Daniel Tarullo, Liquidity
Regulation (Nov. 20, 2014) (“prior to the crisis there
was very little use of quantitative liquidity regulation”);
Jeremy Stein, Liquidity Regulation and Central Banking
(Apr. 19, 2013) (“Liquidity regulation is a relatively new,
post-crisis addition”).
5. Interestingly, the Liquidity Guidance also mentions
the importance of banks correctly identifying and reporting
brokered deposits. It is unclear if this is in response to a
specific issue that regulators have identified or is merely a
general caution.
6. BCBS, Basel III Monitoring Report (Feb. 28,
2023) (indicating that 17 of 181 internationally active banks have
cryptoasset exposures or cryptoassets under custody).
7. Rachel Louise Ensign, Banks Are Breaking Up With
Crypto During Regulatory Crackdown, WSJ (Feb. 16,
2023).
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