The Bank of England has warned financial institutions in the country to limit their exposure to crypto assets. In a letter written by the bank’s deputy governor, the regulator cautioned firms against letting their guard down as the popularity of cryptos soars. It also reminded the firms of the risks that come with handling cryptocurrencies, ranging from money laundering and terrorist financing to high volatility and the possibility of reputational damage. The regulator also expects the firms to act in accordance with the regulations put in place which require them to fully cooperate with the regulatory authorities.

Prudential Treatment of Crypto Assets

Financial institutions have continued to expose themselves to crypto assets as their popularity has risen, and according to the deputy governor, Sam Woods, this necessitated guidelines from the country’s financial industry regulator. In the letter of warning which was addressed to banks, investment firms and insurance companies, Woods noted that blockchain technology has the potential to dominate the financial services industry in the near future before delving into the potential risks to which cryptos expose such firms.

Woods also outlined three risk strategies that the regulator recommends as most appropriate, the first of which relates to the supervisory framework. With cryptocurrencies representing a new and evolving asset class, financial firms should have on their boards someone who is appropriately licensed to handle such entities. The firms must also notify the regulator of their business setups.

Secondly, firms in the bank’s jurisdiction must implement remuneration practices that don’t actively encourage the industry to take unnecessary risk. These firms must also take care to protect themselves from any risk posed, with Woods recommending that they hire relevant experts in the area. The risks to be evaluated are not purely financial; the firms must also consider reputational as well as operational risks.

Guided by these principles, financial institutions should classify crypto exposure in tandem with a comprehensive assessment of the risks which cryptos pose, according to the bank. While leaving room for individual classification of crypto assets based on their features, the regulator insisted that they should not be considered currencies for prudential purposes.

Once the firms conduct a comprehensive analysis on the risks posed by a crypto asset, the findings should be included in their Internal Capital Adequacy Assessment Process or Own Risk and Solvency Assessment. The analysis should include, but is not limited to, the major drivers of the risk, the risk mitigants, and the capital being held in place for such eventualities and an assessment on how variations in the risk drivers affect valuation. Moving forward, the regulator urges all financial institutions to report any planned exposure to crypto assets, accompanied by a breakdown of the risks involved, how the company prepares to handle the situation, as well as the capital put aside to deal with such an occurrence.

The warning letter, though detailed and categorical, is a work in progress, Woods noted. With the crypto industry being relatively new, regulators globally are grappling with regulations and are amending them to encompass the diverse industry. With this in mind, the Bank of England will communicate any updates on its regulations as time progresses, he promised.

The Bank of England has previously shown an interest in central bank digital currencies, with a staff working paper released in May outlining three possible models of CBDCs. They included a model made accessible to financial institutions exclusively, and one in which banks and households were given access, all coming with different features and varying levels of difficulty of implementation.

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