How Crypto Can Affect Bank Liquidity

Banks must take extra care to monitor liquidity when doing business with crypto-asset companies, federal regulators have said.

The joint statement released late last week is the latest in a series of actions and statements from the Federal Reserve, Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) regarding cryptocurrencies and the banking system.

Certain “sources of funding” linked to cryptocurrencies and digital assets “may pose heightened liquidity risks to banking organizations due to the unpredictability of the scale and timing of deposit inflows and outflows”, the regulators said.

The statement cited deposits held on behalf of crypto-asset companies that are ultimately for the benefit of the company’s customers as a liquidity risk, as well as those held against stablecoins.

On the former, the regulators said: “The stability of such deposits may be driven by the behavior of the end customer or crypto-asset sector dynamics, and not solely by the crypto-asset-related entity itself, which is the banking organization’s direct counterparty.”

“Such deposits can be susceptible to large and rapid inflows as well as outflows, when end customers react to crypto-asset-sector-related market events, media reports, and uncertainty. This uncertainty and resulting deposit volatility can be exacerbated by end customer confusion related to inaccurate or misleading representations of deposit insurance by a crypto-asset-related entity.”

On stablecoin-related deposits, the regulators cited similar risks to sudden inflows and outflows.

The statement added that a deposit base concentrated in crypto-related assets and counterparties that have “similar risk profiles” could lead to the effects of volatility being magnified “and liquidity risk therefore may be further heightened”.

Separately, the Fed announced on Thursday that it would not reconsider its decision to deny access to the Federal Reserve System to Custodia Bank. It stated that the application was “inconsistent with the required factors under the law”.

The Fed denied Custodia Bank on the grounds that its “novel business model… presented significant safety and soundness risks” — an assertion that the company denies.