The Fed, FDIC, and OCC publish guidance for banks regarding crypto-liquidity risk

The Board of the Federal Reserve System (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) have issued a statement regarding the liquidity risk presented by certain funding sources of crypto-asset-related entities, and some effective practices to manage such risks.

The agencies added that the statement does not create new risk management principles. Instead, banking organizations should apply existing risk management principles.

The statement highlights the key liquidity risks associated with cryptoassets and cryptoasset sector participants that banking organizations should be aware of, and focuses on certain sources of funding from cryptoasset-related entities may pose increased liquidity risk to banking organizations due to the unpredictability of the scale and timing of deposit inflows and outflows.

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Deposits placed by crypto entities and stablecoin reserves pose liquidity risk

• Deposits placed by a crypto-asset-related entity for the benefit of the crypto-asset-related entity’s customers (end customers). The stability of such deposits may be driven by the behavior of the end customer or the dynamics of the crypto-asset sector, and not only by the crypto-asset-related entity itself, which is the banking organization’s direct counterparty. The stability of deposits may be affected by, for example, periods of stress, market volatility and related vulnerabilities in the crypto-asset sector, which may be specific to the crypto-asset-related entity. Such deposits may be susceptible to large and rapid inflows as well as outflows as end customers react to market events, media reports and uncertainty related to crypto-asset sectors. This uncertainty and the resulting deposit volatility may be exacerbated by end-customer confusion related to inaccurate or misleading representations of deposit insurance by a crypto-asset-related entity.

• Deposits that make up stablecoin-related reserves. The stability of such deposits may be related to the demand for stablecoins, the confidence of stablecoin owners in the stablecoin arrangement and the stablecoin issuer’s reserve management practices. Such deposits may be exposed to large and rapid outflows arising from, for example, unforeseen redemptions of stablecoins or shifts in the markets for cryptoassets.

More generally, when a banking organization’s deposit funding base is concentrated in cryptoasset-related entities that are highly interconnected or share similar risk profiles, deposit fluctuations may also be correlated, and liquidity risk may therefore be further increased.

The Fed, FDIC, and OCC outline effective risk management practices

In light of these increased risks, it is important for banking organizations using certain funding sources from crypto-asset-related entities, such as those described above, to actively monitor the liquidity risk inherent in such funding sources and to establish and maintain effective risk management and controls commensurate with to the level of liquidity risk from such funding sources.

Effective practices for these banking organizations may include, for example:

• Understand the direct and indirect drivers of potential behavior of deposits from crypto-asset-related entities and the extent to which these deposits are exposed to unpredictable volatility.

• Assess potential concentration or correlation across deposits from crypto-asset-related entities and associated liquidity risk.

• Incorporate the liquidity risk or funding volatility associated with crypto-asset-related deposits into contingency funding planning, including liquidity stress testing and, as appropriate, other asset-liability management and risk management processes.

• Conduct 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 such deposit accounts that, if inaccurate, could lead to rapid outflows of such deposits.

In addition, banking organizations are required to comply with applicable laws and regulations. For insured depository institutions, this includes, but is not limited to, compliance with rules for brokered deposits, as applicable, and consolidated reports of condition and income (also known as Call Report) filing requirements