BoE Urges Regulators to Keep Pace with Crypto As It Becomes “Increasingly Integrated Into The Financial System”

While noting that crypto assets “continue to grow and to develop rapidly” while their effect on the UK financial system is limited, the report also covers elevated asset prices due to “‘search for yield’ and higher risk‐taking in a low-interest rate environment.”

The Bank of England said on Friday that crypto assets are becoming more and more integrated into the financial system of the UK. While they do not pose a major risk yet, the central bank calls for increased regulation as they continue to grow and develop rapidly.

“Crypto asset markets continue to grow rapidly but currently pose limited risk to UK financial stability,” said the Financial Policy Committee (FPC) of BoE.

In its Financial Stability report, the Committee then went on to say,

“Regulation needs to develop quickly enough, both domestically and at a global level, to address the risks they could pose in the future.”

Taking a stronger approach than in July, the bank also warned of a “spillover” into traditional markets while noting that interest from institutional investors and banks was a concern.

“The FPC considers that financial institutions should take a cautious and prudent approach to any adoption of these assets.”

FPC pledged to continue to pay close attention to the nascent sector and the relationship between crypto-assets and the UK financial sector.

This year regulators have increased their scrutiny of the cryptocurrency sector, especially stablecoins, as just this week BIS consulted on its proposed rules that they should follow the same principles as banks.

Increased Risk-Taking

In its report, the Committee further talked about “higher leverage and greater risk-taking abroad,” increasing the risk of losses for UK institutions on their foreign exposures.

While Evergrande Group’s ability to meet its financial obligations could have “potential spillovers internationally,” the UK banking system, it said, is resilient to the direct effects of a severe downturn in China and sharp adjustments in global asset prices.

As for increased risk-taking in global financial markets, the FPC found it to be elevated in several markets relative to historic levels.

It noted that ever since the central bank cut interest rates and undertook asset purchases to combat COVID effects, risky asset prices have increased, and their valuations elevated relative to historical norms.

“This partly reflects the improved economic outlook, but may also reflect a ‘search for yield’ and higher risk‐taking in a low interest rate environment.”

If these valuations are to correct shapely in case market participants re‐evaluate the prospects for growth, inflation, or interest rates, such a correction can further be amplified by vulnerabilities that were exposed in March last year, it added.

“This could have consequences for market functioning and financial conditions, and hence the real economy.”

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