Barr says the Fed has the tools to deal with crypto risk

by Arthur · March 9, 2023

Federal Reserve Deputy Chairman for Supervision Michael Barr says managing crypto risk for banks is already well within the capabilities of bank regulators.

The Federal Reserve’s top regulator says the central bank does not need new rules to manage cryptocurrency risk in the banking system.

Fed Deputy Chairman for Supervision Michael Barr delivered his first dedicated comments about crypto regulation Thursday morning at the Peterson Institute for International Economics, a Washington, DC-based think tank.

Barr said he would welcome a codified framework from Congress on crypto regulation, but even without one, the Fed and other banking regulators are already well-equipped to deal with the risks digital assets pose to the banking system, especially those around liquidity and concentration risk.

“In the absence of that comprehensive framework, it is important for regulators to use our existing authorities, both banking regulators and market regulators, to do our best to protect the public and protect the financial system,” Barr said in response to a question from the bank. the event’s moderator, IIE nonresident senior fellow Anna Gelpern. “Inside the banking system, we have the tools we need.”

Barr’s comments come as banking regulators in Washington determine their positions on crypto through policy statements. This guidance has raised concerns among some industry players that the agencies are trying to effectively block crypto firms from access to the banking system.

In his remarks, Barr pointed out that crypto-assets are simply given the same treatment as any other financial product with a similar risk profile.

While the sector has a number of idiosyncrasies that banks need to be aware of — including the volatility of asset prices, the interconnection of various market participants and the prevalence of misrepresentations by issuing parties — Barr said crypto is largely subject to “the same fundamental liquidity and credit risk as traditional assets.” ” Because of this, the Fed’s basic risk management practices can be used effectively.

Barr said the impact of recent failures in the crypto firm on banks has been “limited in the aggregate”, but the episodes stand as proof that crypto can pose a threat to the banks if not properly supervised.

He added that the Fed is cooperate with regulatory bodies around the world to come up with global standards for managing crypto risk in an effort to limit regulatory arbitrage. Barr said the U.S. lags behind the EU and Japan, which have already established crypto-specific guidelines, but added that the U.S. has a long tradition of adapting older rules for modern activities.

“We have an existing regulatory infrastructure that can be adapted to new products and services, and that’s usually the way the United States ends up moving forward with regulating a new type of product — to say, ‘Is this new type of product, like an existing product that we developed?’ and ‘So in what ways can we regulate it using our existing tools?'” he said. “In the absence of Congress adapting another framework, that’s the framework we’re using.”

Barr said the US would not adopt the crypto capital requirements proposed by the Basel Committee on Banking Supervision last year, because these guidelines are aimed at banks that directly own or issue crypto-assets.

“We currently have, to our knowledge, no firms that we regulate that have crypto on their balance sheets, and we’ve made it clear to firms that we don’t think they should. We don’t believe — in our current environment, our current state of governance and control in the sector – that it would be a safe and sound practice for them,” Barr said in response to an audience question. “We don’t yet have the question of how much capital they should have if they have it.”

Barr nods to recent joint statements issued by the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, saying the focus has been on ensuring banks are aware of the risks associated with crypto assets and have plans to manage them. risks.

He also said that banks should ensure that all crypto counterparties are properly vetted to ensure that they are not financing illegal activities or laundering money.

“In light of possible crimes that some crypto companies are now under investigation for, this is not a box check,” Barr said in his prepared remarks, summarizing the Fed’s overall message as, “Don’t jump in and plan to figure out risk management later.”

During his speech, Barr highlighted several promising innovations that could come from the crypto sector, including faster and cheaper payment processing, especially across borders. He also said distributed ledger technology – the basis of so-called blockchain networks – encryption, transaction validation and smart contracts could be incorporated into the traditional financial sector.

He reiterated that the Fed did not want its efforts to mitigate the potential harm to crypto to get in the way of these innovations.

Barr said crypto regulatory guidance from Congress would be most helpful in protecting consumers. He noted that about a fifth of Americans had some form of exposure to crypto assets last year, including many with limited savings who could ill afford the losses they experienced.

While many consumers were harmed by firms that misappropriated customer funds or provided misleading information about deposit insurance, Barr said others simply fell victim to the “innovation cycle.”

“New products often develop slowly at first while market players are unsure of their value or risk, but excitement and enthusiasm can then lead to rapid growth and new products flood the market as a result,” he said. “Participants too quickly assume that they know how the new products work, and new products can appear both safe and lucrative, especially if they have not been tested through bouts of market stress. The innovation cycle turns when this mismatch – between perceived understanding of risk and actual underlying risk – becomes apparent.”

Where congressional action would most benefit the Fed is on the issue of stablecoins, Barr said, noting that they bear a strong resemblance to the types of private money that triggered a series of financial crises in the 19th century that helped establish the Federal Reserve.

“You can have multiple competing forms of private money that are inefficient, you can have very large forms of private money that end up being quite destabilizing. You can think of a stablecoin as a completely unregulated money market fund tied to a payment rail, and it the combination is quite explosive, potentially quite dangerous,” Barr said. “That’s why the chair [Jerome] Powell has made this clear, [former Fed] Vice Char Brainard, when she was at the Fed, made this clear, I have made this clear, that stablecoins really need oversight, because of this risk.