Yesterday Bloomberg reported that Goldman Sachs extended its first cash loan where the security provided was in the form of Bitcoin. A spokesperson said the novelty was structure and around-the-clock risk management.
This follows Goldman’s participation in its first over-the-counter (OTC) Bitcoin option trade last month.
Crypto-backed loans could be rather attractive for banks due to the high interest rate considering the risks. Rates range from 1% to 9% for retail users, depending on the amount of collateral provided.
Bank balance sheet and risk rules
A bank’s profitability depends on how well it can deploy its capital. Banks must comply with Basel rules regarding their capital and risk exposure, which can make holding cryptocurrencies unattractive. Although we dwell on this below, there is a broader perspective.
While getting involved in crypto has some impact on a bank’s balance sheet, it depends on the scale, which is likely to start out small. If there is belief in the future of the cryptocurrency industry, the bank needs to swallow the short-term (small) impact of the balance sheet and start building its expertise and market share.
The rules for crypto have not been finalized, but Basel’s current proposal is a 1250% risk weight for cryptocurrency exposures. This is the same risk weighting as an overdue securities payment.
When Goldman makes the cash loan, they don’t need to put the crypto on the balance sheet. They just treat the cash loan as an asset because the Bitcoin still belongs to the borrower. So one reading is that there is no Basel impact.
However, our reading of the Basel proposals is that these types of crypto-assets are not “eligible forms of collateral”. If this is correct (we asked for confirmation), the loan is treated as an unsecured loan, which has a higher capital requirement than a secured loan.
There are two other potential impacts of Basel. Sometimes banks have the right to sell or re-pledge the collateral, which often happens when the borrower provides securities as collateral.
If Goldman sells or pledges the Bitcoin collateral, it becomes a liability on Goldman’s balance sheet. The current Basel proposal applies the 1250% risk weight to any net long or short position, in this case a short position.
The second scenario is that if the borrower defaults, Bitcoin becomes one of Goldman’s assets, so they have a long position in Bitcoin. However, if Goldman had sold or pledged the Bitcoin and the borrower defaulted, Goldman’s position would be stable.
Banking risk exposures
Earlier this week at the Financial Times Crypto Summit, the CEOs of several major crypto companies weighed in on the risks for traditional institutions to get involved in cryptocurrency.
“Bitcoin is going to bring down a G-SIB (Global Systemically Important Bank) at some point because they don’t understand that the settlement risk is so different between Bitcoin and traditional assets,” said Caitlin Long, a Morgan Stanley veteran who now heads the Custodian Bank. The subject is further explored here.