Terra collapse: Regulators eye stablecoin safeguards and capital rules for banks’ crypto holdings

Global regulators plan to complete work by the end of the year on how much capital banks should hold to cover crypto assets on their books.

Financial watchdogs are trying to catch up with fast-moving developments in crypto markets, whose extreme volatility in recent weeks has caused huge losses for some users.

Last June, the Basel Committee on Banking Supervision proposed that banks set aside enough capital to cover losses on any Bitcoin holdings in full.

Certain tokenised traditional assets and stablecoins could, however, come under existing capital rules and be treated like bonds, loans, deposits or commodities.

Earlier this month TerraUSD, a stablecoin tied to the US dollar, collapsed. The meltdown cost investors tens of billions of dollars as they pulled out of the market in a panic that some have compared to a bank run.

“Recent developments have further highlighted the importance of having a global minimum prudential framework to mitigate risks from crypto assets,” the Basel Committee said in a statement on Tuesday.

“Building on the feedback received by external stakeholders, the Committee plans to publish another consultation paper over the coming month, with a view to finalising the prudential treatment around the end of this year”.

Countries which are members of Basel are committed to applying its agreed principles in their own national rules.

New safeguards for stablecoins

Stablecoins, which play a pivotal role in crypto markets, are digital tokens pegged to the value of traditional assets, such as the US dollar, and are seen as having a bigger role in payments.

The collapse of TerraUSD, a popular stablecoin which was the 10th largest cryptocurrency, caused alarm among central banks and governments. 

A growing number of them are now signalling their intention to introduce new rules and safeguards to protect cryptocurrency users and the stability of the broader financial system.

Regulation looming in the UK

Britain’s finance ministry has set out its own plans for amending existing rules to deal with any major stablecoin collapse that may pose a “systemic” risk.

Banks, insurers and mainstream payment companies must already comply with rules which ensure their deposit accounts, policies or services can be transferred quickly to another provider if they go bust, to help avoid panic and contagion in markets.

“Since the initial commitment to regulate certain types of stablecoins, events in crypto asset markets have further highlighted the need for appropriate regulation to help mitigate consumer, market integrity and financial stability risks,” the UK Treasury said on Tuesday.

“The failure of a systemic digital settlement asset firm could have a wide range of financial stability as well as consumer protection impacts,” the ministry said in a consultation paper.

“This could be both in terms of continuity of services critical to the operation of the economy and access of individuals to their funds or assets”.

While work continues on whether bespoke rules were needed for winding down failed stablecoins, the UK government suggests adapting existing rules to protect consumers from payment firm insolvency.

It has proposed amending the Financial Market Infrastructure Special Administration Regime (FMI SAR) to give the Bank of England (BoE) regulatory oversight over stablecoin issuers – to ensure their systems are robust and can withstand a crisis.

The BoE would also be given “powers of direction” over administrators appointed to deal with collapsed stablecoins.

The British government is calling for feedback on the proposal by August 2.