Will Bitcoin investment of banks in the future be different?

Over the course of Bitcoin’s remarkable rise since the second half of the last year, a large number of institutional investors and listed companies started to invest in this digital asset directly and indirectly. It is true that the market participation by these big guns served as a spark plug for the market when the level of interest was already significantly higher.

While this is true, most of these institutional investors were hedge fund firms that had to pay their investors certain amounts of absolute returns at specified times or asset managers that had to bring high profits to their clients for higher income. Bigger investment banks (IBs) could not make direct investments in Bitcoin as readily. Most banks went as far as supporting investors through Bitcoin custody or, like Goldman Sachs, investing small amounts of client funds in Bitcoin and Bitcoin futures as an experiment.

Although no law explicitly banned them from investing in Bitcoin, many banks were unwilling to do so being conscious of the financial authorities, and others saw it too early to move forward due to high volatility. The lack of regulations as to how to reflect Bitcoin investment in the financial statements seemed to be one of the main reasons for their reluctance.

The Basel Committee on Banking Supervision (simply called the Basel Committee), which consists of central banks of 10 major countries including the US Federal Reserve (Fed), European Central Bank (ECB), and Bank of Japan (BOJ), as well as banking regulators and discusses international rules related to financial institutions, has recognized this problem and been pondering accounting methods for bank investments in Bitcoin. It disclosed the first draft of its regulation on the issue last week.

The regulation basically states that banks investing in a digital asset has to hold safe assets worth 1250% of the total investment amount or increase their equity proportionally. For example, if a bank has invested 100 dollars in Bitcoin, it is considered to have made a risk-weighted investment of 1250 dollars into the most risky asset and is thus required to also hold safe assets like government bonds worth 1250 dollars. Alternately, it can choose to increase its equity by 100 dollars, the amount calculated by multiplying 1250 dollars by the minimum BIS capital ratio 8% (=1250*0.08). Simply put, once the bank invests 100 dollars in Bitcoin, it is obligated to keep aside a capital of the same amount in case it loses it all.

The decision has not yet been finalized, though. The Basel Committee plans to listen to opinions from its member countries on the draft content until September 10 before making the final decision, and the regulation may be eased during this period.

Admitting that many banks have been reluctant to make Bitcoin investment due to absence of accounting regulations, the committee’s decision can eliminate one big hurdle to their market entry. Also, considering that the decision can even become a stepping stone for the financial industry’s entry into the digital assets market, it can be seen rather positively. The Basel Committee may also bring down the risk weight value as the asset gets integrated into the mainstream and its volatility goes down.

Another relief is that the regulation applies the same existing risk weight for the traditional assets to the digital assets in the form of tokenized stocks, bonds and commodities, and that it entirely exempts stablecoins linked to major currencies and the central bank digital currency (CBDC) from risk weight imposition.

It is important to note that the traditional financial system is gradually opening up its door to digital assets. Bitcoin and other digital assets are proving bigger presence that can now influence the risks in the entire financial system.

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