The Bank of England Financial Policy Committee (FPC) and other UK regulators are assessing crypto legislation after publishing reports on financial stability relating to crypto assets and decentralised finance (DeFi).
In that context, Sam Woods, chief executive of the Prudential Regulation Authority (PRA), which is part of the bank of England, has written to CEOs of banks and investment firms to remind them of their obligations under PRA rules regarding exposures to crypto assets.
The letter highlights that crypto asset technology is enabling the creation of new financial assets as well as forms of financial intermediation.
It stated that it has the potential to boost the efficiency and resilience of the financial system through reduced transaction costs, greater choice for users as well as interoperability between payment systems.
However, the PRA also notes that this innovation “can only be sustainable, if these advances are undertaken safely and accompanied by public policy frameworks that mitigate risks and ensure wider trust and integrity in the financial system.”
While firms have limited exposure to crypto assets at the current time, the PRA notes that there is a growing interest from banks and designated investment firms in entering crypto markets.
This may be in taking exposures as agent or principal, holding credit exposures to crypto, or in providing operational services such as custody.
It points out that these markets are relatively new and untested. They offer limited data history, may be characterised by high volatility, and have risk profiles and participants that differ from other financial markets in which these firms operate.
As a result, the PRA urges firms to assess whether the risks inherent in these markets are effectively captured by their existing risk frameworks.
Firms may need to adapt their risk methodologies and calibrations to ensure that they are “appropriately and prudently considering and capitalising the risks”.
The BoE is not alone in its review of crypto assets. The Basel Committee on Banking Supervision and other international bodies are also conducting research on the risks posed to banks when participating in crypto activities.
However, this work is yet to be completed and the PRA believes there “remains a need for the PRA to ensure firms are appropriately and consistently taking account of the risks in the interim”.
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