By Huw Jones and Tom Wilson
LONDON (Reuters) -Banks must set aside enough capital to cover losses on any bitcoin holdings in full, global regulators proposed on Thursday, in a "conservative" step that could prevent widescale use of the cryptocurrency by big lenders.
The Basel Committee on Banking Supervision, made up of regulators from the world's leading financial centres, proposed a twin approach to capital requirements for cryptoassets held by banks in its first bespoke rule for the nascent sector.
El Salvador has become the world's first country to adopt bitcoin as legal tender even though central banks globally have repeatedly warned that investors in the cryptocurrency must be ready to lose all their money.
Major economies including China and the United States have signalled in recent weeks a tougher approach, while developing plans to develop their own central bank digital currencies.
The Swiss-based Basel committee said in a consultation paper that while bank exposures to cryptoassets are limited, their continued growth could increase risks to global financial stability from fraud, cyber attacks, money laundering and terrorist finance if capital requirements are not introduced.
Bitcoin and other cryptocurrencies are currently worth around $1.6 trillion globally, which is still tiny compared with bank holdings of loans, derivatives and other major assets.
Basel's rules require banks to assign "risk weightings" to different types of assets on their books, with these totted up to determine overall capital requirements.
For cryptoassets, Basel is proposing two broad groups.
The first includes certain tokenised traditional assets and stablecoins which would come under existing rules and treated in the same way as bonds, loans, deposits, equities or commodities.
This means the weighting could range between 0% for a tokenised sovereign bond to 1,250% or full value of asset covered by capital.
The value of stablecoins and other group 1 crypto-assets are tied to a traditional asset, such as the dollar in the case of Facebook (NASDAQ:FB)'s proposed Diem stablecoin.
Nevertheless, given cryptoassets are based on new and rapidly evolving technology like blockchain, this poses a potentially increased likelihood of operational risks which need an "add-on" capital charge for all types, Basel said.
'UNIQUE RISKS'
The second group includes cryptocurrencies like bitcoin that would be subject to a new "conservative prudential treatment" with a risk-weighting of 1,250% because of their "unique risks".
Bitcoin and other cryptocurrencies are not linked to any underlying asset.
Under Basel rules, a 1,250% risk weight translates into banks having to hold capital at least equal in value to their exposures to bitcoin or other group 2 cryptoassets.
"The capital will be sufficient to absorb a full write-off of the cryptoasset exposures without exposing depositors and other senior creditors of the banks to a loss," it added.
Joseph Edwards, head of research at crypto brokerage Enigma Securities, said a global regulatory framework for cryptoassets is a positive given that banks in Europe are divided over involvement in the sector.
"If something is to be treated as an universal asset, it effectively needs to meet quorum with regards to how many parties will handle it. This should move the needle somewhat on that," Edwards said.
Bitcoin gained after Basel's announcement, trading up 1.5% at $37,962 at 1053 GMT.
Few other assets that have such conservative treatment under Basel's existing rules, and include investments in funds or securitisations where banks do not have sufficient information about their underlying exposures.
The value of bitcoin has swung wildly, hitting a record high of around $64,895 in mid-April, before slumping to around $36,834 on Thursday.
Banks' appetite for cryptocurrencies varies, with HSBC saying it has no plans for a cryptocurrency trading desk because the digital coins are too volatile. Goldman Sachs (NYSE:GS) restarted its crypto trading desk in March.
Basel said that given the rapidly evolving nature of cryptoassets, a further public consultation on capital requirements is likely before final rules are published.
Central bank digital currencies are not included in its proposals.