U.S. banks have largely stayed out of cryptocurrency custody owing to an SEC Staff Accounting Bulletin (SAB) 121. Following significant pushback from Republican Representatives, at the end of October the Government Accountability Office (GAO) gave a ruling. It stated that because of the impact of the bulletin, it should have been subject to Congressional review but failed to go through that process. Hence, yesterday lawmakers sent a letter to the federal banking regulators – the Federal Reserve, OCC, FDIC and NCUA – asking them to clarify that they will not enforce SAB 121.
Generally if assets are held in custody, they do not appear on the custodian’s balance sheet because they belong to the client. The SEC accounting bulletin applies to all public companies, not just banks. It requires any crypto custodian to show the assets under custody as both an asset and liability on the balance sheet. This is extremely unorthodox. Even Federal Reserve Chair Jerome Powell acknowledged this treatment is not the norm. According to the SEC, the rationale is there is some risk because it’s crypto, hence the need to show a liability.
The secondary impact on banks: custody not viable
However, for banks there’s a far bigger secondary impact. Basel rules, which aim to ensure banks don’t take too many risks, have requirements relating to balance sheets. The net effect is for every dollar of crypto held in custody, banks would have to set aside a dollar of capital. That makes crypto custody extremely expensive.
Plus, even the Basel Committee does not expect crypto to appear on bank balance sheets. The former head of State Street Digital described the SEC rule as “insane”. Other banks concurred that it was a major problem.
And the impact is clear to see. While crypto custody by banks is pretty small globally, it’s non existent in the United States. That’s according to statistics form the Bank of International Settlements, the central bank of central banks. It supports a Reuters report in late 2022 saying banks were reconsidering digital asset custody plans.
Some U.S. institutions will hold back on investing in cryptocurrencies unless they can use their conventional custodians. In other words, banks. There’s a lot of buzz around the potential for spot crypto ETFs. But that spot crypto has to be held in custody and crypto firms are not seen as an ideal option.
When SEC Chair Gary Gensler was quizzed during a September hearing, he claimed the rule only impacted the banks’ accounts. “The bank regulators are free to address how they wish to treat capital,” he said. Yesterday’s letter aims to ensure that bank regulators don’t treat crypto custody differently.