In the early months of this year, the world witnessed an unprecedented series of bank collapses in the United States and Switzerland, a stark reminder of the inherent risks associated with the traditional financial system. Interestingly, many have argued that the cryptocurrency industry could pose a threat to financial stability. However, it seems that bank failures themselves have become a significant risk to the burgeoning crypto market.
The primary goal of financial regulation should be to mitigate financial stability and limit contagion risks to prevent further damage, regardless of where the risks originate. Presently, regulated stablecoin issuers are dependent on banking partners in order to facilitate minting and redemption through fiat money. This indirect access to fiat settlement exposes e-money institutions in the European Union, which are the future issuers of regulated stablecoins or e-money tokens, to disproportionate cost and counterparty risk.
Providing regulated fiat stablecoins with access to central bank accounts could be a crucial step towards increasing the safety of fiat currencies on the internet and fostering payments innovation. This move would allow issuers to minimize their exposure to risks associated with uninsured deposits while separating high-velocity payments activity in stablecoins from the illiquidity of banks’ loan portfolios.
However, the EU’s landmark MiCA regulation may inadvertently hinder this progress. The regulation, which was agreed upon in June 2022, mandates that e-money token (EMT) issuers hold at least 30% of their reserves with credit institutions. Although this measure was intended to improve the liquidity and risk exposure of EMT issuers, it may ultimately burden EMT activity with additional banking and counterparty risk.
A potential solution to this problem is to grant EMT issuers and other e-money institutions direct access to central bank accounts. This would allow EU customers to shield their funds from the credit risk of private banks by moving fiat funds directly to the central bank. In the United Kingdom, e-money institutions have had direct access to the Bank of England’s settlement layer since 2017, a change that was heralded as an opportunity to increase competition and innovation in the payments market.
Even within the EU, Lithuania has already embraced a similar approach. The Central Bank of Lithuania allows e-money institutions and payment institutions to directly open settlement accounts and access the clearing system. As of the end of 2022, 63% of the 84 regulated e-money institutions in Lithuania held customer funds with the central bank, and over two-thirds of e-money reserves in the country were held by the Central Bank of Lithuania.
With negotiations already underway to adjust existing financial regulations like the Settlement Finality Directive, Instant Payments Regulation, and Payment
Source: Cointelegraph
