BIS prudential standards for crypto assets

In line with what was proposed under the June 2022 Basel consultation on the prudential treatment of crypto-exposures, banks will be required to classify crypto-assets into two groups described below and reassess them on an ongoing basis. The classification is conditional on four classification conditions that must be met at all times. It is the responsibility of banks to ensure that the crypto-assets to which they are exposed are compliant with the four classification criteria as described below.

Capital requirements are defined in accordance with the Group in which the crypto-asset is captured. Both groups are then subject to the usual requirements, including operational risk, adapted liquidity, leverage ratio, large exposures, supervisory review and disclosures.

Please find below a more detailed assessment of the standards.

Classification of crypto-assets

Group 1 crypto-assets

Group 1 crypto-assets must meet four classification conditions (explained below). They are divided into two groups:

Group 1a, covering tokenised traditional assets, which are subject to capital requirements based on the existing Basel Framework;
Group 1b, covering crypto-assets with effective stabilisation mechanisms, which are subject to capital requirements and redemption requirements at a predefined amount.

Group 2 crypto-assets

Group 2 crypto-assets cover the remaining crypto-assets that fail to meet the four classification conditions. They are also sub-divided into two groups based on whether they pass the hedging recognition criteria.

Group 2a captures all crypto-assets that do not meet the classifications but pass the hedging recognition criteria. These are to be subject to new conservative capital treatment and can be permitted to have a limited degree of hedging.
Group 2b covers all crypto-assets that do not meet the classification conditions and also do not pass the hedging recognition criteria. Unbacked crypto-assets fall into this category. They are subject to the new conservative capital treatment but hedging is not recognised.

As mentioned, crypto-assets under Group 1 must meet the four classification conditions at all times. These are:

Condition 1: The crypto-asset is either a tokenised traditional asset or has an effective stabilisation mechanism.
Tokenised assets must: be a digital representation of a traditional assets; and pose the same level of credit and market risk as the non-tokenised form of the asset. Crypto-assets with stabilisation mechanisms must: be designed to be redeemable for a predefined amount; have an associated stabilisation mechanism which minimises market value fluctuations and enables a similar risk management as traditional assets; have sufficient information that allows a reliable verification of ownership rights; and pass the redemption risk test	These criteria are not met if the tokenised asset needs to be first redeemed or converted into a traditional asset before direct ownership or if they involve counterparty risks vis-à-vis traditional assets. The redemption risk test implies that (i) the value of the reserve assets equals or exceeds the aggregated peg value of all outstanding crypto-assets; (ii) the crypto-asset is comprised of assets that present minimum market and credit risk; (iii) the governance arrangement is comprehensive and transparent; and (iv) it uses an efficient stabilisation mechanism.
Condition 2: Rights, obligations and interest must be clearly defined and legally enforceable. These need to hold in all jurisdictions where the asset is issued and redeemed as well as be based on legal frameworks that ensure settlement finality. Banks are required to conduct legal reviews on the crypto-asset arrangement.
The crypto-asset must meet the following conditions in order to fulfil condition 2: ensure full transferability and settlement finality at all times with a stabilisation mechanism that provides a robust legal claim; and have a proper documentation of the crypto arrangement at all times.
Condition 3: The crypto-asset and associated network and based technology are designed to mitigate risks and manage the risks that materialise.
This implies that the functions of the crypto-asset (e.g., issuance, validation and redemption) do not pose material risks to transferability, settlement finality or redeemability when applicable; and all elements of the network are well defined in a manner that traces all transactions and participants.
Condition 4: Entities behind the functions of the crypto-asset must (i) be regulated and supervisory entities; and (ii) have a comprehensive governance framework in place that is disclosable.
The above-mentioned entities include transfer and settlement finality operators, wallet providers, custodians of reserve assets and administrators of the stabilisation mechanisms where applicable.

Minimum capital requirements

Requirements for Group 1 crypto-assets

For the assessment of market risk for Group 1 assets, minimum risk-based capital requirements apply. These are to be applied under the Simplified Standardised Approach, Standardised Approach and Internal Models Approach.

Technical infrastructure is also recognised as potentially posing additional risks. To this effect, competent authorities may impose an additional add-on to the capital requirements for exposures to Group 1 crypto-assets.

The assessment of market risk differs between Group 1a and Group 1b.

1. For Group 1a crypto-assets, the credit risk rules as non-tokenised traditional assets apply. This means that credit risk standard rules will apply.

The recognition of the Group 1a crypto-asset as collateral is not automatic. Banks must separately assess whether the asset complies with the eligibility requirements for collateral recognition. Banks with exposures to Group 1a assets must also assess the period of time that the asset can be liquidated as well as the overall depth of the market liquidity.

2. For Group 1b crypto-assets, the standards recognise that different structures exist and therefore it is the responsibility of the bank to analyse the specific structure of the crypto-asset. Banks must separately assess each capitalised credit risk using credit risk standards.

The standards provide a non-exhaustive list of risks that are to be assessed, but it is ultimately up to the bank exposed to Group 1b assets to assess all risks. These can include risks from the reference asset and risk of default from the redeemer.

For the application of Credit Valuation Adjustment (CVA) risk, the same rules apply to Group 1a and Group 1b crypto-assets, and these are to apply with similar rules as those applicable to non-tokenised traditional assets.

Requirements for Group 2 crypto-assets

As mentioned above, Group 2 crypto-assets are divided into two sub-groups depending on whether the relevant crypto-asset meets the hedging recognition criteria. By default, all Group 2 crypto-assets belong to Group 2b unless the bank can demonstrate to the relevant supervisor that the hedging recognition criteria are met.

For an asset to have hedging recognition, three conditions must be met. These are:

The bank’s crypto exposure is either a direct holding of a spot Group 2 crypto-asset, where the derivative or EFT is traded on a regulated exchange referencing only the crypto-asset or where the derivative/EFT referencing the asset is cleared by a qualifying central counterparty.
The bank’s exposure to the asset is highly liquid, meaning that the average market capitalisation was at least USD 10 billion, or the 10% trimmed mean of daily trading volume is at least USD 50 million.
Sufficient data for previous years exists, including 100 price observations or sufficient data on trading volumes and market capitalisation.

Capital requirements for Group 2a assets can be calculated either with a modified version of the Simplified Standardised Approach or a modified version of the Standard Approach. The Internal Model Approach is not applicable for this Group. The modified versions include a separate risk class with the capital requirements specified in the standards.

Group 2b crypto-assets are subject to a conservative treatment. The conservative treatment captures both credit and market risk (credit valuation adjustment risk included). The conservative treatment applies to:

Direct exposures;
Funds or entities of Group 2b assets, for which the material value is primarily derived from the value of the Group 2b asset; and
Equity investments, derivatives and short positions of the above entities.

A risk weight of 1250% is to be applied to the maximum absolute value of the aggregated long and short exposure. This also applies to short positions for the sake of simplicity.

For the application of Credit Valuation Adjustment (CVA) risk, the following applies:

For Group 2a crypto-assets, an amended version of the credit risk standard rules is used. In the amended version, the replacement cost is to take legally enforceable netting of all transaction types into consideration, and a new “crypto” asset class is created to calculate the potential future exposure.
For Group 2b crypto-assets¸ the exposure will be the replacement cost plus the potential future exposure. These are to be multiplied by a specific alpha factor.
To calculate the replacement cost, netting is permitted within eligible netting sets (only between exposures to the same Group 2b assets).

Other requirements

Banks will also be required to comply with other requirements, including:

Minimum capital requirements for operational risk, which should in principle be captured by the operational risk standardised approach through the Business Indicator and the Internal Loss Multiplier. Nevertheless, should this not be enough to capture operational risk, banks are to be required to take further steps to ensure capital adequacy.

For liquidity risk requirements, the treatment of crypto-assets is to be consistent with existing approaches for traditional exposures with equivalent economic risks. Additional risks are also to be reflected in the crypto treatment.

Group 1b and Group 2 crypto-assets cannot be considered high-quality assets (HQLA). This can however be envisaged for Group 1a crypto-assets assuming that both the underlying traditional asset and the tokenised asset satisfy HQLA conditions.
Leverage ratios are to be assessed according to their value for financial reporting purposes.
For large exposures requirements, the treatment follows similar rules to other exposures. Banks will need to identify and apply large exposure limits to each specific counterparty to which it is exposed under the risk-based capital framework.
For Group 2 crypto-assets, exposure limits will be enforced on an aggregated level. The bank’s total exposure to Group 2 crypto-assets should, in general, not be higher than 1% of the bank’s Tier 1 capital and cannot be higher than 2% of the bank’s Tier 1 capital. Should the 2% limit be exceeded, exposures will be subject to capital requirements that apply to Group 2b crypto-asset exposures.

The standards also provide for bank risk management, and allocate responsibilities for both banks and supervisors. Amongst its risk management provisions, banks must account for e.g., the risk of the underlying crypto technology (including DLT validation mechanism, service accessibility, etc.), legal risks, cyber risks and anti-money laundering considerations. These considerations are not exhaustive.

Should shortcomings be identified, supervisors can consider additional measures, including additional capital charges and loss provisioning.

General guiding principles will apply for the disclosure of exposures. On a regular basis, banks are to disclose the following information about all crypto-assets exposures: 1) direct and indirect exposure amounts; 2) capital requirements; and 3) accounting classifications.

On top of the general principles, the information is to be complemented with qualitative information as well, which among other things include business activities related to crypto and the risk management policies in place.

Reviewing and monitoring of the standards

The standards are envisaged to be amended, as the Basel Committee on Banking Supervision will issue additional refinements and classifications to crypto-assets in due course. The regular monitoring exercise under Basel III will continue, but in addition the following aspects will be subject to specific monitoring and reviewing:

Statistical and redemption risk tests – The reliability of statistical tests to identify low-risk stablecoins will be assessed and potential additional requirements for inclusion in Group 1b will be considered accordingly.
Permissionless blockchain – The ability of crypto-assets operating in permissionless blockchains to mitigate risks in a way that influences their inclusion in Group 1b will be further assessed.
Group 1b crypto-assets received as collateral – The Committee will continue to monitor the treatment of Group 1b crypto-assets as collateral. The potential for certain Group 1b crypto-assets to be used as collateral for capital requirement purposes will be reconsidered accordingly.
Group 2a criteria and hedge recognition – The thresholds for hedging recognition criteria will continue to be monitored and adjusted accordingly.
Calibration of Group 2 exposures – Thresholds for exposures’ limits will continue to be assessed and adapted if necessary as the crypto-assets market evolves.

Next steps

The standards will now be incorporated as a new Chapter in the consolidated Basel Framework.

The global standards will be implemented by 1 January 2025.