The Federal Reserve has issued recommendations to financial institutions, warning them against lending out crypto clients’ deposits owing to the high liquidity risk associated with crypto assets. In place of using these deposits as collateral, the guidelines suggested that banks keep cash on hand.
However, the guidance has sparked debate within the financial industry, as it contradicts the proposal put forth by Custodia Bank. Custodia Bank had suggested that banks could lend out deposits made by their crypto customers, provided that they held the appropriate amount of cryptocurrency as collateral.
Regulating crypto services risks
The Federal Reserve’s guidance comes at a time when the popularity of cryptocurrencies is on the rise, and many banks are exploring ways to offer crypto-related services to their customers. Nevertheless, the guidance raises questions about how these services should be regulated and managed to mitigate risks.
According to a joint press statement issued by the Federal Reserve, recent events in the cryptocurrency assets industry have shown that preset financing sources from cryptocurrency assets-related businesses may be associated with greater levels of liquidity risk.
The statement emphasizes the significance of good risk management methods in monitoring and managing liquidity risks linked with cryptocurrency-related financing sources. This involves stress testing on a regular basis, solid liquidity contingency planning, and effective risk reporting and monitoring.
While the joint statement does not create new risk management principles, it serves as a timely reminder of the need for banking organizations to apply existing risk management principles when dealing with crypto-asset-related entities.
Crypto Risk Management Imperative
Banking firms have an obligation to get an understanding of the dangers and difficulties posed by the cryptocurrency business and to implement suitable risk management policies in order to protect themselves.
Despite these concerns, many in the financial industry believe the Federal Reserve’s guidance is too restrictive. They argue that banks should be allowed to offer lending services to their crypto customers as long as they implement appropriate risk management practices and hold sufficient collateral.
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