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Banking on crypto raises risks for traditional lenders
Industry observers caution over the trade-off between securing a first-mover advantage and dealing with reputational risks
Feb 22, 2022
Singapore
AS more banks in South-east Asia plant their flags in the cryptocurrency sphere, some industry observers have sounded a note of caution over the trade-off between securing a first-mover advantage and dealing with reputational and operational risks.
A foothold in this nascent space could boost trading and custodial fees for traditional lenders over time. But revenues from these diversified streams are unlikely to be significant in the next few years, some experts said.
Meanwhile, the fast-changing regulation of cryptocurrencies and crypto-focused entities in the region could raise compliance costs or curb existing or planned business activities.
"Where banks have weaker risk controls, there may be a greater potential for crypto engagement to expose them to legal risks, for example around money laundering and terrorism financing. Reputational risks could stem even from activity that is legal, for example if customers perceive banks have tacitly endorsed crypto trades that subsequently turn sour," said analysts from Fitch Ratings in a January commentary.
Regulators in South-east Asia have varying levels of tolerance for crypto trading. Indonesia, for instance, allows the trading of crypto assets on the commodities exchange; but authorities have warned that financial institutions are not allowed to offer and facilitate sales of crypto assets. Singapore, on the other hand, adopts a welcoming stance to crypto operators; but the country's central bank has stressed that cryptocurrencies are not suitable for most retail investors.
Reputational and operational risks
Crypto engagement among regional banks is growing. Singapore's DBS, for example, launched a wholly owned crypto and digital asset trading platform in 2020 for accredited and institutional investors. In November last year, Thailand's Siam Commercial Bank acquired a 5 per cent stake in Thai cryptocurrency trader BitKub. And Union Bank of the Philippines is reportedly planning to offer trading and custodial services for cryptocurrencies.
Fitch has flagged potential reputational risks for banks entering this space.
"By publicly planting their flags in crypto, banks are indirectly staking their reputation on it because many customers would, rightly or wrongly, perceive that as a form of endorsement by the bank that they are a legitimate asset class," Fitch analyst Willie Tanoto said in an interview with The Business Times.
He acknowledged, however, that direct financial risks are limited as most banks in the region are neither diving headlong into cryptocurrencies nor loading large proprietary exposure to crypto assets.
In fact, the Bank of International Settlement's proposal to assign punitive capital risk weightings on crypto assets will likely deter banks from investing too heavily or playing aggressively in the crypto space.
Barbara Crane, a partner in financial services advisory at KMPG Singapore, said traditional banks will face higher reputational risks than other crypto players. "They are under more intense scrutiny as established, trusted entities. Any setback could pose a reputation hit on other peripheral services under them. Hence, banks will need to ensure that they have robust governance and controls in place and are able to respond to these risks in a timely manner," Crane said.
Operational risks also must not be underestimated, Fitch said, noting that few crypto companies have developed a track record of stability for their systems.
"We view cybersecurity threats, such as scams and hacks involving exchanges, as another prominent risk. There can also be issues around ESG (environmental, social and governance) exposures, given the energy intensive nature of some cryptocurrency mining and verification operations," Fitch said.
Cryptocurrencies can be promising
Still, KPMG's Crane said it is crucial for banks to establish themselves in the crypto sector as they seek to attract investors who are looking for ways to expand their portfolios.
Crypto is likely a long-term play, Crane said, noting that she does not see it achieving mainstream adoption for a few years.
Ivan Tan, an analyst at S&P Global Ratings, said the crypto market's capitalisation remains a fraction of traditional equities and debt capital markets.
"Cryptocurrency has shown significant growth, but from a low base… We expect (it) to be a small, albeit growing, share of revenue for banks," Tan said.
He added that South-east Asian banks are entering the crypto space primarily to expand their product offerings to existing clients, rather than competing head-on with existing players.
Ulisse Dell'Orto, managing director for Asia-Pacific at blockchain data platform Chainalysis, said that while there may be reputational risks for banks to partner with crypto platforms that are not well-regulated, there are longer-term risks for banks that are resistant towards cryptocurrencies. This could include losing brand awareness, existing customers and new potential customers to other more innovative banks, he said.
Fitch's Tanoto, however, holds a different view. "Cryptocurrencies can be promising, but they are not inevitable," he said.
The distributed ledger technology underlying cryptocurrencies could potentially be beneficial to process efficiency and business competitiveness, he said, but much work remains to troubleshoot kinks and attain practical implementation and widespread adoption.
"Some of the associated reputational and operational risks can conceivably ebb over time as the asset class matures, markets deepen, and price volatility subsides. However, until there is regulatory certainty and normalised price volatility, its relevance as a 'currency' or a medium of banking services is likely to be overshadowed by its allure as a source of potential trading profit," he said.
Risks can be managed: banks
Some banks say the risks can be managed. DBS, which runs one of the world's first bank-backed digital exchanges, said it has taken a "prudent and measured approach" to the growing digital asset economy.
DBS Digital Exchange leverages strengths of the larger banking group by giving customers the assurance of institutional-grade security, business continuity, and robust processes to prevent, monitor, detect, and mitigate fraudulent activities, said its chief executive Lionel Lim.
OCBC, which is studying the possibility of developing its own crypto exchange, acknowledged that cryptocurrencies have yet to overcome certain hurdles, including trust, price volatility and regulatory acceptance. The risks are inevitable given that crypto is a relatively new asset, said its Singapore head of wealth management Tan Siew Lee.
"That being said, many of the risks can be mitigated through a clear definition of the business model for cryptocurrency financial services, and introducing new policies, processes and controls to manage the risk," she said.
UOB's head of group corporate banking Leong Yung Chee acknowledged that cryptocurrencies bring with them a double-edged sword. UOB is "very cognisant" of its risks, he said.
"On one hand, the decentralised nature can potentially lead to further improvements and increased efficiency in payment, transaction and investment landscape.
"On the other hand, on-going challenges regarding the underlying security of crypto custody, uncertainties regarding the potential use of crypto to facilitate money laundering and terrorist financing, the use of cryptocurrencies for excessive speculation, will all result in operational, financial and consequently reputational risks," Leong said.
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