How Federal Regulators Treat Crypto and Banks

What is Risk Management?

The risk management process involves identifying, evaluating, and controlling risks to a company’s resources and profits. These dangers can be caused by many things, such as monetary risk, legal obligations, technological problems, strategic management blunders, accidents, and natural calamities.

A practical risk management approach aids a business in taking into account all potential hazards. Risk management also examines the link involving threats and the potential adverse cascade effects on an organisation’s planned objectives.

Because it concentrates on predicting and comprehending risk across a business, this all-encompassing approach to risk management is occasionally called enterprise risk management. Enterprise risk management (ERM), in addition to concentrating on internal and external threats, highlights the need to manage positive risk. Positive risks are chances that, if taken, might boost a company’s worth or, alternatively, hurt it. Every risk management program’s goal is, in fact, to protect and enhance corporate value by taking calculated risks rather than completely eradicating all risks.

What is the Importance of Risk Management?

Probably never before has risk management been more crucial than it is right now. Because of the quickening speed of globalisation, the dangers that contemporary companies confront have gotten more complicated. The widespread usage of digital technology nowadays has led to the ongoing emergence of new threats. Environmental pollution or Climate Change has been labelled a “danger multiplier” by risk specialists.

Corporations and their governance bodies are reevaluating their risk management plans as the globe grapples with these crises. They are re-evaluating their exposure to risk and investigating the risk-taking process. The group that ought to be engaged in risk management is being re-evaluated.

The possibilities of a more proactive strategy to risk management are being considered by businesses that now employ a reactive strategy, protecting against prior hazards and altering processes when a new challenge causes harm. Supporting sustainability, resilience, and corporate agility is becoming increasingly popular. Businesses also investigate how advanced governance, risk, and compliance (GRC) systems and artificial intelligence technology may enhance risk management.

Risk Management in Banking Industry

Risk management is a vital and quickly changing aspect of a bank’s operations. Risk management basically is calculating the likelihood that an adverse event will result from a specific course of action. It is also crucial in the world of business. A business can never expand or turn a profit if it doesn’t take risks.

Although they can change, the risks that banks typically manage are:

• credit risks;
• market risks;
• operational risks, including reporting risks and risks associated with data governance;
• liquidation risks;
• risks associated with technology and information, including; and
• strategic risks.

However, banks are subject to risks coming from external circumstances over which they have no direct influence, including such global warming risks.

Why do banks control risk?

Banks manage risks for a variety of reasons, including:

• avoid loss;
• guarantee survival;
• keep their reputation intact;
• preserve the interests of stakeholders;
• abide by the rules and regulations; and
• safeguard the bank’s credit standing.

Nonetheless, seeing as banks and the financial system are so crucial to both the domestic and global economies, inadequate risk management has far-reaching effects. This was made clear during the financial crisis of 2007–2008, when authorities had to band together to rescue banks.

Because a bank’s operation revolves around the generation of money, it may limit or even halt lending if it runs into problems, even on a relatively small scale. This impacts how readily available money is to businesses and inhibits economic growth.

For this reason, both domestically and globally, financial organisations and banks are controlled.

Risk Management in Cryptocurrency Industry

Typically, cryptocurrency enthusiasts are impatient to start trading and generating money and neglect to think about the size of their portfolios or how to handle their money. New traders frequently risk in search of a big win while paying little attention to strategies that promote sustainability. If you recognise yourself in that description, it is worth looking at specific risk management techniques that, when properly implemented, can safeguard you and allow you to continue in the industry without emptying your savings.

There can be no question that bad things will happen to you when trading cryptocurrencies. Terrible experiences include trades that result in the opposite of what you wanted, odd price surges, errors, and numerous other undesirable occurrences. Each trader who deals in cryptocurrencies does so at some level of risk. Since they frequently leverage, cryptocurrency futures traders tend to assume more risks. Your trading balance is impacted, and you might lose all of your cash, if proper risk management procedures are not followed.

Risk management strategies record how you intend to control your threat when investing. They safeguard you against the negatives of your transactions and maintain you in command of your expenses. When the proper crypto trading techniques are already in place, the guidelines will keep you safe and assist you in getting the desired outcome.

8 Principles for Crypto Risk Management:

1. Have a Good Trading Strategy
2. Just make investments you can manage to lose.
3. Measure how much you risk per trade
4. Restrict Your Leverage Usage
5. Regularly Determine Your Risk-to-Reward Ratio
6. Employ stop-loss orders
7. Protect Your Profit With Take Profit
8. Possess reasonable expectations

Risk management is crucial for successful trading. Therefore, new and struggling traders should take it seriously. Despite how basic they may appear, failing to implement them might cause you to experience trading difficulties.

Banks are involved in risk management. Regulators appear to ignore this in their efforts to severely curtail the banking sector’s activities related to cryptocurrencies, acting instead on the presumption that “any risk is a bad risk.” It is true that the cryptocurrency market has gone through a very difficult period and that some banks have been hurt. Yet, according to two experts, authorities should ensure that banks take the proper risks.

They claim that the current approach may lead to an increase in risk over time.

The Comptroller’s Office, the Federal Reserve, and the Federal Deposit Insurance Corp. released a succinct public declaration in the first few days of 2023 outlining dangers to banks resulting from activity connected to crypto-assets.

The declaration reassures readers that financial institutions “are neither forbidden nor discouraged from providing banking services to consumers of any specified class or kind, as authorised by law or regulation,” as is customary these times for authorities.

Nevertheless, the regulatory authorities mention that they remain in the process of evaluating “whether and how” virtual currency operations can be carried out in accordance with “safety and soundness, consumer protection, legal permissibility, and compliance with applicable laws and regulations,” which is only further supported by more current behaviour by the Federal Reserve.

By dumping any links with companies that deal with cryptocurrencies, regulators require banks to “de-risk”, according to those who are keeping an eye on the changing attitudes and behaviours towards cryptocurrency.

In “Operation Chokepoint,” an intra-agency initiative orchestrated by the Justice Department with help from federal bank authorities, we have witnessed this scenario.

The objective is to stress financial institutions to break off relationships with accepted but unfavourable companies that are thought to increase the risk of fraud and money laundering. The advertising received harsh criticism and was ultimately condemned even by the authorities. Nonetheless, the overall result was to steer respected companies into less trustworthy and open firms that provided financial services.

Keeping Statutory Déjà Vu at Bay:

In the aftermath of the cryptocurrency disasters we saw in 2022, the temptation to circle the financial sector is reasonable, but it is ill-advised. In the near term, retaining innovative, complex technology beyond the governmental purview could feel more secure. Yet over time, then that will increase the danger.

Risk management has historically been an objective of the banking industry

The modern monetary companies that securely store and transmit money and other valuables primarily depend on banks and other regulated financial entities. The technology employed to do specific tasks has significantly advanced from previous times. This will carry on. Thus, reputable, controlled financial institutions must be able to respond to new risks of all kinds and keep supporting the economy.

It is nonetheless far too premature to predict if cryptocurrency will fulfil its aspirations or whether conventional cards and other payment systems or other platforms, will out-innovate cryptocurrency channels, reports from the “crypto winter” aside. Authorities and other federal authorities, however, must avoid prejudging the results. Furthermore, they shouldn’t limit banks’ ability to compete by limiting them to a select few crypto-related markets.

Any other options than Banks?

Banks are knowledgeable actors that have experience running banking systems and managing risks. Do we genuinely desire to exclude all crypto transactions from a sector that possesses the knowledge and responsibility necessary to learn how to perform these things correctly?

Authorities who prevent banking institutions from experimenting safely will limit their contributions, raising the possibility that the system will become divided and financial institutions will be unable to participate in what may turn out to be a crucial component of the current global financial architecture.

Ring-fencing banks from cryptocurrency are not only unneeded, but it is also foolish. Banks are in the business of taking risks, even if these risks might occasionally have very negative consequences. Think about the past as well as the present:

• Financial institutions have been destroyed by mortgage loans and investments tied to mortgages.
• Peer-to-peer transactions, real-time settlement, and digital payments all involve a considerable potential for theft, cons, and operational blunders.
• Presently, there is a lot of uncertainty surrounding commercial real estate financing, a “go-to” for many banks as we assess the effects of the shift from offices to work-from-home and hybrid setups.
• When credit card and buy-now, pay-later balances increase and customers are already pushed thin by inflation, consumer credit raises the risk curve.
• Using machine learning effectively has enormous potential for enhancing risk management and customer service, but it takes considerable ability to do so.

Regulatory authorities are not really advocating for banking institutions to be isolated from those operations, though. They anticipate that they will be vigilant in controlling risks.

The True Threat: Crypto? Or Is That Simply the Standard Concentration Risk?

We must admit that the cryptocurrency failures of last year actually managed to have a negative effect on a limited number of institutions. Legislators are likely to consider those occurrences as supporting their strategy. In fact, authorities have already noted previous difficulties at certain banks with a focus on cryptocurrencies as proof that such operations present risks that may be impossible to handle wisely.

Without discussing the details, we believe that these instances have less to do with cryptocurrencies as technology and more to do with managing traditional banking risks (such as concentrations and liquidity problems).

Risk Was Not Invented by Crypto:

Unsafe risk concentration has already been an ongoing challenge for the banking industry. It’s also essential to comprehend and continuously monitor structural threats. These problems are complex and not exclusive to cryptocurrencies.

Regulatory authorities should really not concentrate on mitigating risk while supervising cryptocurrency and banks’ engagement in it, as they ought not to in any of these other sectors. Making ensuring banks take suitable risks ought to constitute the goal.

“Appropriate risks” might mean many different things. We interpret this to suggest that individuals should not even incur dangers they do not fully grasp or cannot measure. They cannot handle those risks by necessity.

For the remaining risks, the emphasis should be on limiting excessive risk-taking compared with the strength of a particular institution or the soundness of the financial sector in its entirety.

Several Regulations Prevent Banks from Investing in Bitcoin

Authorities now appear to emphasise that any danger is a risky investment related to crypto-related operations. The most recent intergovernmental advisory is merely the most current in several authorities’ moves indicating banks should avoid cryptocurrency. They consist of:

• Putting up barriers to stop banks from working on anything related to cryptocurrency without first receiving regulatory clearance or a supervisory nod;
• Providing accounting guidelines that essentially prevent banks from providing cryptocurrency custodial rights;
• Implementing international capital requirements that will also subject cryptocurrency-related operations to prohibitive capital costs and limit cryptocurrency commitments to 1% of Tier 1 capital;
• Providing rigorous requirements for using facilities and master entities at the Federal Reserve Bank;
• Prohibiting entry on proposed bank charters that include cryptocurrency-related business ambitions; and
• Neglecting to keep their word after releasing a plan in late 2021 that they would provide more detailed guidelines throughout the duration of 2022 to set more explicit rules of the road for banks.

As 2023 approaches, authorities must be more explicit about the practices that banking institutions can participate in connected to cryptocurrencies and how they can manage the risks. Authorities “simply saying no” to everything related to cryptocurrencies won’t assist banks, the banking industry, or financial stability, as Federal Reserve Board Governor Michelle Bowman acknowledged in a speech. The business requires a balance between what is worthwhile and what doing it “well” actually looks like to accomplish this properly.