Financial Stability Report Gives Rare Insight into Bank of Israel’s Attitude Towards Crypto Assets – Commentary

introduction
Risks posed by crypto

Comment

introduction

It’s rare to get a glimpse of the central bank’s mindset. Such an opportunity was recently presented by the Bank of Israel’s Financial Stability Report for the second half of 2021. In its report, the central bank decided to include, for the first time, a special chapter on crypto assets. (crypto) and their effect. on banking financial stability.

The report highlights several concerns regarding the growing adoption of crypto by consumers and financial institutions. These concerns include various familiar risks – such as crypto volatility, operational risks, cyber risks, reputational risks, and legal risks – all of which have been widely associated with crypto and discussed publicly in recent years. However, the report also details the specific risks that crypto poses to banks, which are worth noting.

Risks posed by crypto

The first concern mentioned is the growing exposure of non-bank financial institutions to crypto. This indirectly exposes the banking system to crypto-related risks, as banks are often the financiers of non-bank financial institutions. The report argues that this should lead to tighter control of banks’ interests in non-bank financial institutions.

The second concern relates to the issue of “stablecoins” (i.e. crypto tokens pegged to a stable asset, such as the US dollar). The report argues that stablecoins can affect the long-term financial stability of the traditional banking system. The concern is that wider adoption of stablecoins could lead to customers ultimately choosing to withdraw funds from their bank accounts, buy stablecoins and deposit them with virtual asset service providers in hope for better returns than the banking system can provide. According to the report, this could lead to reduced liquidity for banks, which could potentially increase the cost of credit for consumers. Interestingly, the only regulator in Israel to publicly express his position in this regard is the Governor of the Bank of Israel, who claimed that stablecoins should be supervised by the central bank.

Furthermore, as the demand for global stablecoins increases, especially from those living in smaller countries, the report argues that they could weaken local currencies, which could have a significant impact on the local monetary policy of these countries and their financial autonomy.

Finally, the report notes that the growing demand for decentralized financial platforms (Defi) providing services traditionally linked to banks, such as loans and savings, could in turn lead to a drop in demand for banking services. The report further highlights that Defi apps pose a unique regulatory challenge; while they offer financial products and services that would normally be regulated, such regulation is inadequate and needs to be further adapted to better address the financial nature of crypto, as well as the risks arising from the nature of the decentralized network. This requires multinational cooperation and effort both in setting agreed standards and in enforcing them.

Comment

Examining these risks as described in the Bank of Israel’s report raises the question of whether they reflect genuine concern about the financial stability of the banking system or a more fundamental concern about the ability of banks to commercially compete with the growing crypto market. There is no doubt that consumers are looking for alternatives, and some find crypto products more appealing than traditional banking alternatives. There is also no doubt that the crypto space needs to be regulated to reduce market risk and provide more transparency. However, regulation should not suppress competition; that should encourage him. Banks shouldn’t fight crypto; they should compete with it. If they choose the latter, the ultimate beneficiaries would be the consumers.

For more information on this, please contact Roy Keidar at Yigal Arnon & Co by phone (+972 3 608 7777) or email ([email protected]). The Yigal Arnon & Co website is accessible at the address www.arnon.co.il.

Student Arkadius Stark assisted in the preparation of this article.

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