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Pinpoint and outline several worldwide approaches to regulating unbacked crypto assets, including the BCBS proposal on how banks should treat their crypto exposures.

FRM® Part II · Current Issues in Financial Markets · Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets · FRM2.CI.6.c

The idea

Jurisdictions take different approaches to unbacked crypto assets. Some ban activity, as China did in 2021. Some apply existing securities or commodities law case by case, as the United States largely does. Others build bespoke licensing regimes, such as Japan's registration of exchanges or the EU's MiCA. The Basel Committee set a prudential standard for banks in December 2022. Group 1 covers tokenised traditional assets (1a) and stablecoins that meet classification conditions (1b), and receives treatment equivalent to the traditional counterpart. Group 2 covers unbacked crypto assets and failing stablecoins. Group 2b has a 1250 percent risk weight, so the charge follows from the minimum capital ratio. Capital = exposure × 1250% × 8%. The product of the two percentages is 100%, so the capital charge equals the exposure. Group 2 exposures should stay within 2 percent of Tier 1 capital and generally below 1 percent. Exam point: Group 2 is deliberately punitive.

Formulas

Capital charge on a Group 2b crypto exposure

capital = exposure × 1250% × 8%

exposure
the bank's Group 2b crypto exposure

The product of the 1250% risk weight and the 8% minimum ratio is one, so the charge equals the exposure. Breaching the 2% of Tier 1 limit moves all Group 2 exposures here.

A practice question

From the question bank, with the reason each wrong option is wrong.

Under the Basel Committee's December 2022 standard on the prudential treatment of cryptoasset exposures, in which group does an unbacked crypto asset such as Bitcoin fall?

  1. Group 1a, as a tokenised traditional asset.Why not: Group 1a covers tokenised versions of traditional assets with the same legal rights, which Bitcoin is not.
  2. Group 1b, as a stablecoin with an effective stabilisation mechanism.Why not: Group 1b requires a stabilisation mechanism and redeemability; unbacked assets have neither.
  3. Group 2. - correct
  4. It is excluded from the standard because banks are not allowed to hold it.Why not: The standard sets capital treatment for exposures banks may have; it does not exclude unbacked assets.

Group 1 is for tokenised traditional assets and qualifying stablecoins. Unbacked crypto assets and stablecoins that fail the classification conditions fall in Group 2, which has far more conservative treatment.

A harder one

A bank has a USD 40 million Group 2b exposure to unbacked crypto assets. The 2b risk weight is 1250 percent and the minimum total capital ratio is 8 percent. The capital requirement is closest to:

  1. USD 40 million. - correct
  2. USD 4 million.Why not: Reads 1250 percent as 125 percent (1.25), cutting the capital charge by a factor of ten.
  3. USD 500 million.Why not: Reports risk-weighted assets (40 x 12.5) rather than capital, skipping the 8 percent.
  4. USD 3.2 million.Why not: Applies 8 percent to the exposure and ignores the 1250 percent risk weight.

RWA = 40 x 12.5 = USD 500 million; capital = 8% x 500 = USD 40 million. A 1250 percent weight at an 8 percent ratio is a dollar-for-dollar charge.

The hardest tier

A bank has Tier 1 capital of USD 30 billion, total assets of USD 600 billion and Group 2 exposures of USD 0.9 billion. Under the Basel Committee Group 2 exposure limit, which conclusion is correct?

  1. The exposure is 0.15 percent of total assets, far below the limit, so no action is needed.Why not: Measures against total assets, but the limit is based on Tier 1 capital.
  2. The exposure is 3 percent of Tier 1 capital, above the limit, but the bank only has to notify its supervisor.Why not: Ignores that exceeding the limit carries a capital consequence.
  3. The exposure is 3 percent of Tier 1 capital and is acceptable because the 1 percent threshold applies only to Group 1.Why not: Misreads the 1 percent threshold, which relates to Group 2 exposures, and ignores the 2 percent limit.
  4. 3 percent of Tier 1 capital, above the 2 percent limit, so all of its Group 2 exposures face Group 2b treatment. - correct

Exposure / Tier 1 = 0.9 / 30 = 3 percent. Group 2 exposures should not exceed 2 percent of Tier 1 capital and should generally stay below 1 percent; the base is Tier 1, not total assets. Breaching the limit moves all of the bank's Group 2 exposures, not only the excess, to the more punitive Group 2b treatment.

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