The BIS, Banks and crypto – the impact of capital requirements

The Bank for International Settlements (BIS) has yesterday published their “Second consultation on the prudential treatment of cryptoasset exposure”. There is a lot of nonsense written about the ideas and impact, e.g. here and here.

The consultation is a very interesting read. But no, the BIS does not support banks in holding more crypto. Here is the misunderstanding, Some people read:

A bank’s total exposure to Group 2 cryptoassets must not be higher than 1% of the bank’s Tier 1 capital at all times.

and think: banks will be allowed to hold up to 1% of reserves in cryptocurrencies such as Bitcoin (BTC). Or: The 1% cap will apply to the total exposure, meaning that a bank that already has 0.5% of its capital in BTC can at most have another 0.5% invested in another unbacked cryptoasset.

However, the capital requirements are much (much, much) more complex. Firstly, the consultation introduces an exposure limit (I refer to page 6 of the consultation) not a wider limit. Secondly, in very simple words, what is missing in the line of reasoning mentioned above, is the fact that banks need to have a total amount of capital equal to at least 8% of risk weighted assets. Now, the question is what is the risk weight for each crypto position? This wil depend on whether the crypto qualifies as Group 1 or Group 2a or 2b. BTC is Group 2b (I won’t explain all the details here):

60.89 For each separate Group 2b cryptoasset to which they are exposed, banks must apply a risk weight of 1250% to the greater of the absolute value of the aggregate long positions and the absolute value of the aggregate short positions in the cryptoasset.

In other words, owning BTC will result in a 100% capital charge.

There are many nuances here. For example, the specifics of the crypto, netting and hedging, banking book/trading book but my key point is that the BIS has not fundamentally changed its critical position towards crypto’s and only made some amendments following their first consultation.