US federal regulators warn banks of crypto-related liquidity risks

• Three United States federal regulators have issued a warning to banks about crypto-related liquidity risks
• The warning relates to volatility in deposit inflows and outflows related to crypto-entities

The United States federal regulators have released a statement warning banks about crypto-related liquidity risks. The regulators involved are the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC). And, the joint statement issued by the three regulators states,

“certain sources of funding from crypto-asset-related entities may pose heightened liquidity risks to banking organizations due to the unpredictability of the scale and timing of deposit inflows and outflows”

Banks with higher crypto-related deposits face heightened liquidity risks

The regulators further cited deposits made by crypto platforms that are for the benefit of their customers and stablecoin reserve deposits as examples of the unpredictability of deposit inflows and outflows. The regulators also stated that the deposits made by firms for their customers’ benefit are influenced by several factors. This includes customers’ behavior to market events and uncertainty, market volatility, and other factors related to the market.

Meanwhile, the stablecoin reserve deposits depend on the demand for the coin and the confidence it has secured among users. These deposits could face large and rapid outflows in case of “unanticipated stablecoin redemptions or dislocations in crypto-asset markets”. The regulators stated banks could face heightened liquidity risk if their deposit funding is mainly from crypto-related firms. They said,

“More broadly, when a banking organization’s deposit funding base is concentrated in crypto-asset-related entities that are highly interconnected or share similar risk profiles, deposit fluctuations may also be correlated, and liquidity risk therefore may be further heightened.”

The regulators have urged banks to keep a tab on such liquidity risks. In addition, banks have to maintain effective risk management for crypto-related funding sources.

Notably, this is the second time the federal regulators have warned banks about digital assets-related risks. In a statement issued on January 3, 2023, the regulators warned banks about virtual currency fraud and scams, legal uncertainties, crypto firms’ misleading representations, market volatility, and others. The federal regulators also stated that they were evaluating how digital asset-related activities by banks could be “conducted in a manner that adequately addresses safety and soundness, consumer protection, legal permissibility, and compliance with applicable laws.”