Fed’s Barr: Concerned about the backlash of cryptocurrencies in the financial system

Nov 15 (Reuters) – Michael Barr, the Federal Reserve’s top financial regulator, said on Tuesday he was concerned about risks in the non-bank sector, including cryptocurrencies, for which the US central bank and other regulators have low visibility.

“We are concerned about unknown risks in the nonbank sector,” Barr said in response to a question during an appearance before the Senate Banking Committee. “That obviously includes crypto business, but more generally risks in parts of the financial system where we don’t have good visibility, we don’t have good transparency, we don’t have good data. This can create risks that affect the financial system that we regulate” .

Barr’s remarks came in his first congressional testimony since becoming the top Fed cop on Wall Street over the summer and added his prepared comments to the committee that was keeping an eye on stresses in the financial system amid to a weakened economy.

He also signaled that tighter oversight of the cryptocurrency arena is in the offing, an issue that took on added urgency with last week’s crash of cryptocurrency exchange FTX, which filed for bankruptcy on Friday. Panicked traders had wrung about $6 billion off the platform in 72 hours, and a rival exchange pulled out of a bailout deal.

Recent events in the cryptocurrency markets, Barr said in his written testimony, “although they have occurred primarily outside the banking sector, have highlighted the risks to investors and consumers associated with new and new asset classes and assets when they are not accompanied by strong barriers”.

“We don’t want to stifle innovation, but when regulation is lax or behind the curve, it can facilitate risk-taking and a race to the bottom that endangers consumers, businesses and the economy and discredits new products and services among consumers and investors”.

That said, Barr said market regulators are in a better position to provide an initial regulatory framework for the cryptocurrency industry.

“Market regulators are…the first place to start in this space,” Barr said in response to a senator’s question. “They have existing authorities. We want to make sure they are fully utilized. Some of the activity that was taking place in this space purported to continue in a way designed to evade oversight and regulation. I think we saw the huge human costs of that type of activity .”

QUESTIONS ABOUT CRYPTO CUSTODY

Barr and other top regulators from the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency who appeared before the committee were pressed by Senator Patrick Toomey, the panel’s ranking Republican, as to why they failed to provide guidance to banks on the forming relationships, such as custody services, with crypto firms that could foster greater oversight of the industry.

Toomey expressed concern that the Fed is signaling that it could provide guidance to banks looking to provide custody services for crypto assets to place those assets on their balance sheets, which would increase their capital requirements. Banks are not required to place other types of custody assets on their balance sheets.

“Wouldn’t this impose a significant cost on banks if they were actually required to put all… cryptocurrencies on their balance sheets?” Toomey asked Barr.

“To date we have seen banks operating in a rather cautious manner. There are very few institutions that are currently looking to engage in custody activity,” said Barr. He said his understanding of the Securities and Exchange Commission’s recent accounting interpretations for publicly traded banks was that banks should hold capital against cryptocurrencies held in custody in a way not required for traditional custody activities.

“So that spread would impact the bank’s decision-making process,” he said.

NOT IN RECESSION BUT SOFTENING THE ECONOMY

Barr, who is also a monetary policymaker with a permanent vote on the Fed’s interest rate decisions, said the weakening outlook for the economy was another key risk to the financial system as the central bank hikes interest rates. interest to fight inflation which is, in his view, “too high”.

“I think we’re going to see a significant weakening of the economy,” Barr told lawmakers, though he declined to offer a specific forecast on how much the US unemployment rate could rise. Then he added, “there’s not a recession right now. We’re in a period of slower economic growth.”

Since March, the Fed has raised its key interest rate from near zero to a range of 3.75% to 4.00%, including four consecutive hikes of three-quarters of a percentage point. Rate hikes are likely to continue into early 2023, although their pace is seen to slow down from here on out amid some promising signs that inflationary pressures have started to ease.

However, tighter financial conditions engineered by the Fed pose risks for banks, Barr said.

“A weaker economy could put households and businesses under stress and, therefore, the banking system as a whole.”

Additional reporting by Lindsay Dunsmuir; Editing by Lisa Shumaker and Andrea Ricci

Our Standards: The Thomson Reuters Principles of Trust.

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