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The New York City Subway system uses “mind the gap” signs to remind passengers to beware of the space between the platform and the train.
Recent events in the world of finance have recast this warning, as gaps in oversight led to breaches, which risked ultimately leading to a systemically risky situation. The events again underscore the crucial role that sound regulation and effective supervision play in maintaining financial stability, and highlighted three principles to keep in mind when shaping crypto-asset regulations.
The first principle echoes George Santayana: “Those who cannot remember the past are condemned to repeat it.” It is important to look at the lessons learned from historical banking crises as well as recent events on both sides of the Atlantic, and to apply these lessons to the oversight of crypto markets.
The second principle is that the requirements for good governance and strong risk management reduce the risk of bank failures. The collapse of FTX showed what happens when firms don’t meet these requirements. The regulatory framework should ensure that all crypto-asset service providers (CASPs) have sound governance and risk management arrangements in place, including binding external auditing and financial disclosure requirements.
The third and final principle is that what worked for us in the past may not necessarily be fit for purpose in the future. The latest bank failures and financial market dislocations appear to indicate that we are doomed to repeat the failures of the past, these dislocations occasionally revealed new weaknesses that must be addressed. We will have to take a closer look, for example at how Silicon Valley Bank (SVB) lost $42 billion in deposits in five hours and the impact social media had in sparking a bank run, to ensure that any future regulation and supervision address these issues. We need to be thinking about how the crypto world presents new challenges.
These principles provide a useful lens for looking at the current situation and at existing efforts to regulate crypto-assets, e.g. through the application of BCBS standards and the Markets in Crypto-Asset Regulation (MiCA), and for figuring out how improve these efforts even further.
In the last weeks we saw the collapse of three banks in the United States and bank rescues in both the United States and Switzerland. SVB had a high growth business model – tripling its assets between 2019 and 2022 – which presented correlation risk between its loans to tech start-ups and its deposit base.[1] Silvergate Bank, Signature Bank and First Republic Bank were all exposed to crypto risks. We have also recently witnessed the forced sale of a global systemically important bank with a weak business model under stressed conditions to another. Neither scenario is new. We know that it is prudent for management first and foremost as well as supervisors to take steps to recognise risks related to rapid growth and to reduce risks stemming from correlation and weak business models. We need to follow the first principle and remember the lessons of the past. While the events of the last few weeks are too recent for us to fully analyse at this stage, both the Federal Reserve and the Swiss authorities will conduct careful reviews that will undoubtedly shed more light on any lessons that we should take on board.
In the banking world, we are used to a system that relies on a home-host supervision model and comprehensive consolidated supervision through supervisory colleges. But what has worked in the past may not cover us for the future. In the securities world, the recognition of regulatory equivalence regimes forms the basis for oversight. In the crypto world, no such framework exists. The collapse of FTX last November raised questions about gaps in the framework. How can we achieve consolidated oversight of firms that claim to have no headquarters at all? What does no primary jurisdiction or an unfamiliar location for a firm’s head office mean in terms of having a home country banking supervisor or an equivalence regime for securities oversight? The lack of a traditional central point of entry poses challenges for our current regulatory and supervisory approaches. Although the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) have acknowledged the need for a global regulatory and supervisory framework for crypto-assets, I am afraid that this project is still very much in its infancy. The basis for home-host cooperation is, first and foremost, sound regulation and supervision in each jurisdiction. In the crypto world, however, the very concept of borders and jurisdictions is being challenged. How can we supervise firms that have no physical borders? We need to put more thought into imagining what international coordination will look like and how it can be effective in regulating the crypto world....
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