US agencies recommend old risk management principles for crypto-liquidity

In a joint statement released by three US federal agencies, the banking sector was advised against creating new risk management principles to counter liquidity risks arising from vulnerabilities in the crypto asset market.

The Board of the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) issued a statement reminding banks to use existing risk management principles when addressing crypto-related liquidity risks.

The joint statement highlighted the key liquidity risks associated with cryptoassets and related participants for banking organizations. The risks highlighted relate to the unpredictable extent and timing of inflows and outflows of deposits.

In other words, the federal agencies raised concerns about an event where massive sales or purchases would negatively impact the liquidity of the asset — potentially incurring losses for investors.

The federal agencies specifically highlighted two cases to showcase the liquidity risk associated with cryptocurrencies:

1. Deposits placed by a crypto-asset-related entity for the benefit of the crypto-asset-related entity’s customers (end customers).
2. Deposits that make up stablecoin-related reserves.

In the first place, price stability depends on the behavior of investors, which can be affected by “stress, market volatility and related vulnerabilities in the crypto-asset sector.” The second type of risk is related to the demand for stablecoins. The joint statement read:

“Such deposits can be sensitive to large and rapid outflows stemming from, for example, unanticipated stablecoin redemptions or shifts in crypto-asset markets.”

While the trio agreed that “banking organizations are neither prohibited nor discouraged from providing banking services” under the law of the country, it recommended active monitoring of liquidity risk and establishing and maintaining effective risk management and controls over crypto offerings.

The agencies recommended four key practices for effective risk management to banks, which include performing robust due diligence and monitoring of crypto assets, incorporating liquidity risk, assessing the correlation between crypto offerings, and understanding the direct and indirect drivers of potential deposit behavior.

Related: Approach with caution: US banking regulator’s crypto warning

On January 3, the same three federal agencies – the Fed, the FDIC and the OCC – issued a joint statement highlighting eight risks in the cryptosystem, including fraud, volatility, contagion and similar issues.

The agencies jointly stated:

“It is important that risks associated with the cryptoasset sector that cannot be mitigated or controlled do not migrate to the banking system.”

The statement highlighted the possibility of changing crypto regulations with references to agencies’ “case-by-case approach to date.”