Federal banking regulators issue joint statement on liquidity risks to banking organizations resulting from crypto-asset market vulnerabilities

Liquidity risks related to certain sources of funding from crypto-asset-related entities

The federal banking regulators reiterated in the Joint Statement, just as they did in January, that banking organizations are neither prohibited nor discouraged from providing legally permissible banking services to customers of any specific class or type. They cautioned, however, that certain sources of funding from crypto-asset-related entities may pose heightened liquidity risks to banking organizations due to the unpredictability of the scale and timing of deposit inflows and outflows, including:

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

• Deposits that constitute stablecoin-related reserves. The stability of such deposits may be linked to demand for stablecoins, the confidence of stablecoin holders in the stablecoin arrangement and the stablecoin issuer’s reserve management practices. Such deposits can be susceptible to large and rapid outflows stemming from, for example, unanticipated stablecoin redemptions or dislocations in crypto-asset markets.

The federal banking regulators also warned that, when a banking organization’s deposit funding base is concentrated in crypto-asset-related entities that are highly interconnected or share similar risk profiles, deposit fluctuations may also be correlated, further heightening liquidity risk.

Effective risk management practices

In light of the heightened liquidity risks posed by certain sources of funding from crypto-asset-related entities, the Federal banking regulators observed that it is important for banking organizations that rely on such funding to actively monitor the liquidity risks inherent in such funding sources and establish and maintain effective risk management and controls commensurate with the level of liquidity risk from such funding sources. The federal banking regulators provided the following examples of effective risk management practices:

• Understanding the direct and indirect drivers of potential behavior of deposits from crypto-asset-related entities and the extent to which such deposits are susceptible to unpredictable volatility.
• Assessing potential concentration or interconnectedness across deposits from crypto-asset-related entities and the associated liquidity risks.
• Incorporating the liquidity risks or funding volatility associated with crypto-asset-related deposits into contingency funding planning, including liquidity stress testing and, as appropriate, other asset-liability governance and risk management processes.
• Performing 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.

The Joint Statement also reminded banking organizations of their compliance obligations with respect to applicable laws and regulations, including the FDIC’s brokered deposits rules (12 C.F.R. § 337.6).

Footnotes

_{1. The term “crypto-asset” is used in the Joint Statement broadly to refer generally to “any digital asset implemented using cryptographic techniques.”}

^{2. Our client alert on the Joint Statement on Crypto-Asset Risks to Banking Organizations is available here.}