In a move concerning crypto, the European Banking Authority (EBA), in collaboration with the European Systemic Risk Board (ESRB) and the Financial Stability Board (FSB), has announced a joint initiative to investigate the interconnectedness of legacy banks with non-bank financial institutions (NBFIs).

Shining A Light On Shadow Banking

As disclosed by EBA chair José Manuel Campa in an interview with the Financial Times, this move aims to shed light on the potential risks and contagion effects that could arise between banking and non-banking financial sectors in “stress scenarios.”

The EBA’s approach marks a significant step in understanding the extent of banks’ exposure to the crypto sector, including hedge funds, crypto platforms, and private equity.

The EBA’s investigation will involve assessing the banks’ balance sheet exposures to non-banks, delving into the murky waters of the NBFIs, which Campa calls an “obscure sector” characterized by diverse and often “non-homogenous” data quality.

According to FSB data, this initiative comes at a time when the total value of assets possessed by NBFIs is estimated to be above $200 trillion.

EU’s Crypto Stance, A Balancing Act?

The European Union’s approach to crypto regulation has been cautiously neutral, and this latest investigation forms part of a broader regulatory framework. While the comprehensive Markets in Crypto-Assets (MiCA) Regulation is not expected to be fully implemented until 2026, the EU has not held back in its regulation efforts.

This includes probing banks’ digital currency exposures and imposing stringent measures on unverified crypto users. In July last year, European lawmakers introduced significant limits, capping transactions at €1000 for unverified crypto users and €7000 on cash payments for the same category.

These measures were part of a larger plan to revamp Anti-Money Laundering (AML) regulations across the EU. French lawmaker Damien Carême, spearheading the AML negotiations, emphasized that these laws target money laundering and do not particularly ban crypto transactions, noting:

We are absolutely not preventing crypto transactions. It’s just when identification isn’t possible.

Simultaneously, the EBA has been actively preparing for the adoption of MiCA regulations. In the same month, the authority advised stablecoin issuers to prepare for MiCA compliance to avoid abrupt business adjustments in the future.

The EBA’s principles call for complete disclosure of rights and risks associated with token ownership, equitable treatment of all holders, and robust reserve, recovery, and redemption arrangements.

The Association for Financial Markets in Europe (AFME), a key European trade body, strongly recommends incorporating Decentralized Finance (DeFi) within the MiCA Regulation framework.

The AFME emphasizes that overlooking DeFi could lead to regulatory arbitrage, undermining the intended effectiveness of the upcoming regulatory measures.

Featured image from Unsplash, Chart from TradingView