Bank Failures and Crypto: Why Central Bank Access is Crucial for Stablecoin Safety and Payment Innovation

Remember the banking turmoil of March 2023? It wasn’t just traditional finance that felt the tremors. The failures of several banks in the US and Switzerland served as a stark reminder: risks in the banking sector can ripple outwards, impacting even the seemingly separate world of crypto-assets. Ironically, this time, it was the crypto industry that felt the pinch from traditional finance, highlighting a critical interdependency we can’t ignore.

The Unexpected Link: Bank Failures and the Crypto World

For many, the narrative has been about the potential risks crypto poses to traditional finance. But the events of early 2023 flipped the script. How did bank failures become a stability risk for the crypto-asset industry?

• Stablecoins Rely on Banks: Regulated stablecoin issuers, those aiming to maintain a 1:1 peg with fiat currencies, depend on banking partners for the crucial processes of minting (creating new stablecoins) and redemption (exchanging stablecoins back for fiat).
• Counterparty Risk Exposure: This reliance exposes e-money institutions (EMIs) in the European Union to significant counterparty risk. If a banking partner fails, it can disrupt the entire stablecoin ecosystem.
• Costly Operations: Navigating this reliance on banking partners also adds disproportionate costs for these EMIs.
• Innovation Bottleneck: Ultimately, these challenges stifle innovation and limit competition within the burgeoning payments market.

The Solution? Direct Access to Central Banks

So, what’s the answer to this unexpected vulnerability? A key step towards a safer and more innovative financial landscape lies in granting regulated fiat stablecoins direct access to central bank accounts.

MiCA and the Lingering Banking Risk: Are We Missing a Trick?

The EU’s landmark Markets in Crypto-Assets (MiCA) regulation is a significant step forward. However, even with MiCA’s provisions, challenges remain. One key requirement mandates that e-money token issuers hold at least 30% of their reserve assets with credit institutions. While intended to ensure stability, this still leaves a substantial portion of reserves exposed to banking and counterparty risk. Shouldn’t we aim for even greater security?

A Safer Path Forward: Central Bank Accounts for All EMIs

Imagine a scenario where EMT issuers, and indeed all e-money institutions, could directly access central bank accounts. What would the benefits be?

• Enhanced Customer Protection: Moving fiat funds directly to the central bank would shield EU customers from the credit risk associated with private banks. This offers a significant layer of protection.
• Reduced Counterparty Risk: Direct access drastically reduces reliance on private banking partners, mitigating the risk of disruption from bank failures.
• Leveling the Playing Field: This move would create a fairer competitive environment between banks and non-bank payment providers.

Real-World Examples: Where This is Already Working

The idea of non-bank financial institutions accessing central bank accounts isn’t just theoretical. Several countries have already taken this progressive step:

• The United Kingdom: Since 2017, e-money institutions in the UK have had direct access to the Bank of England’s settlement layer. This has demonstrably fostered competition and innovation in the payments sector, leading to more diverse and resilient payment arrangements.
• Lithuania: The Central Bank of Lithuania allows both e-money and payment institutions to open settlement accounts and directly access the clearing system. Remarkably, over two-thirds of e-money reserves in Lithuania are held directly with their central bank.

These examples clearly demonstrate the positive impact of granting direct central bank access.

Time for Action: How Can the EU Catch Up?

The evidence is compelling. So, how can the EU replicate this success and unlock the full potential of its payment ecosystem?

• Review the Settlement Finality Directive: A targeted review, perhaps in conjunction with the review of the Payment Services Directive (PSD) or the Instant Payments Regulation, is essential.
• Address the Level Playing Field: As highlighted in the impact assessment of the PSD, leveling the playing field between banks and non-banks in the payment market is a critical objective.

The Bigger Picture: Benefits Beyond Stability

Granting e-money institutions access to central bank accounts isn’t just about mitigating risks. It offers broader benefits to the financial system:

• Increased Safety and Liquidity: Non-bank financial institutions would benefit from enhanced safety and liquidity.
• Greater Innovation: A more level playing field encourages innovation and the development of new payment solutions.
• Reduced Concentration Risk: In a financial system increasingly dominated by global systemically important banks, this move promotes diversification and reduces concentration risk.

Conclusion: A Unique Opportunity for the EU

The case for granting e-money institutions access to central bank accounts has never been stronger. The recent bank failures served as a wake-up call, highlighting the interconnectedness of the financial system and the vulnerabilities that exist. By taking this decisive step, the EU has a unique opportunity to bolster the safety and resilience of its financial system, foster greater innovation in the payments market, and ensure the safe integration of fiat currencies onto the internet. Let’s not miss this chance to create a more competitive and robust financial future.