In a further response to the events over the past several months that have rattled the crypto industry, on February 23, 2023, the Federal Reserve Board (“FRB”), Federal Deposit Insurance Corporation (“FDIC”) and Office of the Comptroller of the Currency (“OCC”) (together the “Agencies”) issued their second joint statement (the “Statement”) in less than two months regarding crypto-asset-related risks. As opposed to the Agencies’ prior statement (the “January Statement”), previously discussed here, which focused broadly on crypto-asset-related activities undertaken by banking organizations, the Statement focuses specifically on liquidity risks posed to banking organizations from accepting certain crypto-asset-related deposits. The Statement re-emphasizes and elaborates on previously identified heightened risks from banking organizations accepting these deposits from crypto-asset-related entities, and advises heightened risk management practices to mitigate these risks. The Statement, however, is explicit that it does not prevent banking organizations from accepting deposits from “customers of any specific class or type,” nor does it create “new” risk management principles for banking organizations to follow.
The Statement highlights two types of deposits that the Agencies identify as presenting heightened liquidity risks: (i) deposits from crypto-asset-related entities for the benefit of their customers, and (ii) deposits that constitute stablecoin-related reserves. The potential liquidity risks the Statement identifies include:
- risks driven by a crypto-asset-related entity’s customers, including potentially large and rapid inflows and outflows of deposits as customers react to events in the crypto sector, potentially exacerbated by customer confusion over misleading representations of deposit insurance by crypto-asset-related entities;
- risks related to the vulnerabilities of the crypto-asset sector itself and of the banking organization’s crypto-asset-related entity counterparties;
- stablecoin run risk; and
- contagion risks related to the interconnected nature of crypto-asset-related entities and the impact such interconnections can have on the correlation of deposit fluctuations.
While likely motivated to some extent by very recent events, the identification of these risks is not new. The above risks have been noted both by the Agencies in the January Statement, and by the Financial Stability Oversight Council in October 2022 (as discussed in a previous blog post).
After identifying these heightened risks, the Statement advises that banking organizations monitor the inherent liquidity risks presented by crypto-asset deposits and provides examples of effective risk management practices and controls for banking organizations that utilize crypto-asset deposits as sources of funding. Examples of effective practices provided by the Agencies include:
- understanding drivers of potential behavior of such deposits and their volatility;
- assessing potential concentration or interconnectedness of risks across deposits;
- incorporating such liquidity risks into contingency funding planning, including liquidity stress testing, and other asset-liability governance and risk management processes; and
- robust due diligence and ongoing monitoring of crypto-asset-related entities that establish deposit accounts.
The Statement is explicit that it is not creating “new risk management principles;” rather, it steers banking organizations toward “existing risk management principles.” In fact, the Agencies’ multiple direct or indirect references to brokered deposits in the Statement indicate that the Agencies’ expectations may be similar to the approach the Agencies took in heightening the risk management framework surrounding brokered deposits in the 1980s and the 2010s. Furthermore, this approach appears to be consistent with how the Agencies are treating other new areas of risk, such as climate-related financial risk, where the Agencies have acknowledged in proposed guidance that those risks can be incorporated into existing risk management frameworks.
It is notable that the Statement begins by advising that “banking organizations are neither prohibited nor discouraged from providing banking services to customers of any specific class or type.” Given certain safety and soundness concerns raised in the January Statement, this is a less negative message from the Agencies that may be reflective of an emerging perspective among both state and federal regulators that recognizes the staying power of crypto-assets but attempts to create a robust risk management framework. Nevertheless, the recent statements are still likely to elicit more caution from banking organizations looking to enter the crypto-asset space.
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For more discussion and analysis of guidance related to crypto-asset risks see our other posts:
- Federal Banking Agencies Release Joint Statement on Crypto-Asset Risks to Banks
- New FSOC Report Encourages Congressional Action on Digital Assets
- NYDFS Issues Crypto-Custody Guidance to Protect Customers During Bankruptcies
