EU Banks Face New Rules for Crypto Asset Risk Management

The European Parliament has published a legal draft that confirms the imposition of restrictive crypto rules for banks in the European Union. The published legal draft not only addresses crypto currencies but also more broadly the credit risk, market risk, operational risk and credit valuation adjustment risk practices of European Banks. Under the proposed rules, crypto assets would be treated as the riskiest type of asset, and banks would have to disclose their direct and indirect exposure to crypto while awaiting more detailed regulations.

The planned rules could have a significant impact on how the traditional financial sector interacts with digital assets. Banks would be required to place the maximum possible risk weight on crypto assets, set at 1250%, which could discourage them from holding crypto. For comparison, the proposed risk weight for the next risky asset category, "unrated assets with a residual maturity of over 1 year," which includes various types of corporate and infrastructure loans, is 250%. As a result, the banks may choose to reduce their exposure to crypto to avoid additional capital requirements.

The proposed rules aim to ensure that the involvement of financial institutions in crypto asset-related activities is adequately reflected in the Union prudential framework. The explanatory text by the parliament’s Economic and Monetary Affairs Committee emphasizes the need to mitigate the risks of crypto assets for financial stability, especially in light of the recent adverse developments in the crypto-assets markets.

The draft law seeks to implement international capital standards set by the Basel Committee on Banking Supervision. The committee has proposed imposing a hard cap on banks’ holdings of unbacked crypto such as bitcoin (BTC), a suggestion that is not currently included in the EU’s legal draft. The European Commission is expected to propose further legislation by June to ensure that international capital standards are properly implemented.

Before passing into law, the EU member governments meeting as the Council and the parliament must agree on the proposals. However, the fact that the European Parliament has published a legal draft is a strong indication that the proposed rules are likely to become law. The introduction of these rules could affect how banks and other financial institutions interact with crypto assets, and may also impact the broader crypto market.

Crypto advocates have expressed concerns that the proposed rules could stifle innovation and limit the growth of the crypto market. They argue that such a risk weight would make it difficult for banks to hold crypto assets, which could reduce the liquidity of the market and harm its development. However, others have argued that such regulation is necessary to protect consumers and ensure the stability of the financial system. For example, MiCA, the EU's imminently expected regulatory framework for Crypto-assets, has been praised by many, and broadly welcomed by market participants.

It remains to be seen how these proposed rules will affect the broader crypto market, but they are likely to be closely watched by crypto investors, regulators, and other stakeholders. As the crypto market continues to evolve, it is clear that there is a need for clear and consistent regulation to ensure its stability and growth. The proposed rules are one step towards achieving this goal, but they may not be the final word on the matter.