Could stablecoin regulation pose a new risk to the banking system?

WASHINGTON — When it comes to major market turbulence, banks escaped last week’s TerraUSD crash largely unscathed.

Terra and its corresponding crypto coin Luna fell last week, losing almost all of their value and sending the crypto market into a selloff. It was an existential moment for crypto proponents and a prescient moment for its detractors, raising fundamental questions about how digital assets are regulated and by whom.

“A stablecoin known as TerraUSD has had a run and has declined in value,” Treasury Secretary Yellen said during testimony before the Senate Banking, Housing, and Urban Affairs Committee. last Tuesday. “I think it just illustrates that this is a rapidly growing product and there are risks to financial stability and we need a proper framework.”

Treasury Secretary Janet Yellen said recent volatility in the cryptocurrency market highlights that “there are financial stability risks [from stablecoins] and we need an appropriate framework.

Bloomberg News

Yet despite broader financial stability fears and the recent entry of big financial players into the crypto space, most of Terra’s meltdown has remained confined to the world of digital assets.

It’s a victory for financial regulators, experts say. The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. have been cautious about how banks are dipping their toes into crypto-related activities.

“I really commend banking regulators for making sure banks kept crypto off their balance sheets,” said Todd Phillips, director of financial regulation and corporate governance at the Center for American Progress. “Banking regulators deserve a lot of credit for keeping the financial system safe.”

Banks, it seems, have been successful in keeping these kinds of volatile assets off their balance sheets, and the run on Terra doesn’t clash with a more traditional bank run that could profoundly destabilize markets.

“The good news to come out of the recent crypto market turmoil is that it hasn’t spilled over into the financial sector and the banking system, and that absolutely strengthens the hand of prudential regulators when it comes down to it. acts to view with great skepticism the involvement of banks in digital assets,” said Lee Reiners, executive director of the Global Financial Markets Center at Duke University. “In some ways, it’s a bit like a political success. ”

Yet the race on Terra is prompting policymakers to act with more urgency when it comes to regulating digital assets. Crypto companies have spent large sums trying to convince Washington that digital assets are a safe and growing place to invest money, but last week’s unrest could have undermined those efforts.

The Biden administration, through a report from the president’s task force, has previously suggested that stablecoins — which underpin digital asset markets — be required to have a bank charter, a path that Yellen defended last week before Congress.

But there are broader concerns about the risk stablecoins pose to bank balance sheets, contradicting what some are saying to keep the financial system safe during Terra’s collapse.

Terra was also what is known as an “algorithmic” stablecoin, meaning its value is determined by a financial algorithm rather than a pool of assets, so a run on Terra is less risky for the economy. entire financial system. If another asset-backed stablecoin were to experience a run, that could be a bigger issue.

“Dodd-Frank was aimed at reducing the risk of the big banks, and now the president’s task force is considering that we’re going to add more risk to these institutions,” Rep. Pat McHenry, RN.C., said Thursday. Yellen’s House Financial Services Committee Hearing.

Reiners said adding stablecoin risk to bank balance sheets is a valid concern, especially after seeing the run on Terra.

“There is no uniform agreement on what to do on stablecoins,” he said. “There are well-known issues within crypto; why would we want to import these problems into the banking system? There is no perfect solution here.

The hope, Reiners said, is that banking regulation for stablecoins will act in the same way to prevent runs as it does with banks — allowing oversight of banking regulators, deposit insurance, and requiring that stablecoins are backed by relatively liquid assets.

The other option would be to treat stablecoin issuers like the financial system treats money market funds, with a disclosure-based regime.

“The problem with the money market approach is that it hasn’t worked very well,” he said. “Twice in 12 years the Federal Reserve has had to support money market funds.”

Phillips said the market chaos means legislative proposals that create a separate charter for stablecoin issuers have a better chance of becoming law.

Proposals that give traditional banks a freer hand to hold crypto assets on their balance sheets, meanwhile, will have a harder time, he said.

“I would have a hard time seeing Congress being really willing to put stablecoins on bank balance sheets now,” he said. “And if there are institutions that had hoped to integrate crypto into their balance sheets, I think they will have to wait a very, very long time for that to happen, if at all.”

Banking regulation would have other benefits, said Thomas Vartanian, executive director of the Financial Technology & Cybersecurity Center. Banking regulators could require stablecoin issuers to have strong anti-money laundering processes in place, which could mitigate the risks posed by hackers and other security issues.

“All of this would happen under the watchful eye of regulators, which is not happening now,” Vartanian said. “The question is, what is the legitimate market need for this hardware that actually saves money, makes the system more secure and, in turn, can attract customer confidence? By driving it to banks , it forces these questions to be asked and answered, because I think regulators would demand that they be asked and answered.

About Ruben V. Albin

Check Also

COLUMBIA BANKING SYSTEM ANNOUNCES AGREEMENT TO SELL THREE BRANCHES IN NORTHERN CALIFORNIA TO FIRST NORTHERN BANK

Branches are divested to meet US Department of Justice (DOJ) requirements for Columbia Ongoing merger …