Banking regulators release joint statement on liquidity risks with cryptoassets

On February 23, 2023, the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) released a joint statement highlighting key liquidity risks associated with crypto-assets and crypto-asset participants “due to the unpredictability of the scale and timing of deposit inflows and outflows” and reminding banking organizations to apply existing risk management principles to effectively manage those risks.

More specifically, federal regulators warned banking organizations that using sources of funding from crypto-asset-related entities that are for the benefit of the crypto-related entities’ customers may be influenced by periods of stress, market volatility, and related vulnerabilities in the crypto-asset sector, which may or may not be specific to the crypto-asset-related entity. Such deposits, the joint statement warned, can be susceptible to “large and rapid inflows as well as outflows, when end customers react to crypto-asset-sector-related market events, media reports, and uncertainty.”

The agencies further warned that the 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.” The federal regulators also addressed issues concerning deposits that constitute stablecoin-related reserves, which “can be susceptible to large and rapid outflows stemming from, for example, unanticipated stablecoin redemptions or dislocations in crypto-asset markets.”

The joint statement emphasized the importance for banks to establish and maintain effective risk management and controls commensurate with the level of liquidity risks presented. The joint statement does not establish any new risk management principles, but rather encourages banks to rely on existing risk management principles.

For example, effective practices highlighted by the federal regulators in the joint statement include:

• Understanding the direct and indirect drivers of potential behavior of deposits from crypto-asset-related entities and the extent to which those deposits are susceptible to unpredictable volatility.
• Assessing potential concentration or interconnectedness across deposits from crypto entities and the associated liquidity risks.
• Incorporating the liquidity risks or funding volatility associated with crypto-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-related entities that establish deposit accounts, including assessing the representations made by those crypto-related entities to their end customers about such deposit accounts that, if inaccurate, could lead to rapid outflows of such deposits.

Learn more about the implications of the joint statement by contacting either of the authors.