Fed's Michael Barr says FTX turmoil shows crypto risk to financial system

WASHINGTON — Michael Barr, vice chairman for supervision at the Federal Reserve, told the Senate Banking Committee that he's concerned about risks outside the banking system, particularly in the cryptocurrency sector. 

The panel's hearing was the first for the Fed's top banking cop since his nomination was confirmed over the summer. It comes shortly after the unwinding of the crypto firm FTX, which has brought finger-pointing at Washington for not more strictly policing the risks of digital assets. 

"We're concerned about the risks that we don't know about in the nonbank sector," Barr said. "That includes obviously crypto activity, but more broadly risks in parts of the financial system where we don't have good visibility, we don't have good transparency, we don't have good data. That can create risks that blow back to the financial system that we do regulate."

Sarah Silbiger/Bloomberg

While the tumult in the crypto industry has so far been insulated from banking, some policymakers fear the two are becoming increasingly intertwined. 

"Most of this activity is occurring outside of the ambit of banking regulation," Barr said in his written remarks. "But recent events remind us of the potential for systemic risk if interlinkages develop between the crypto system that exists today and the traditional financial system." 

Barr was joined by other top banking regulators, including acting Chairman of the Federal Deposit Insurance Corp. Martin Gruenberg and acting Comptroller of the Currency Michael Hsu, for the first day of the two prudential regulator hearings, which were scheduled before FTX's collapse. 

Sen. Pat Toomey of Pennsylvania, the ranking Republican on the committee, pressed regulators on their plans to offer guidance to banks to custody crypto assets. He said that the OCC, under Hsu, has discouraged banks from entering into the business. 

"If banks can demonstrate that they can do that activity in a safe, sound and fair manner, we're all ears," Hsu said. 

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Barr said it would be "useful" for the Fed to provide custody guidance for banks on crypto assets. 

"I think we've seen in the context of recent events that if you had a set of firms that are trying to operate outside the regulatory perimeter, trying to avoid compliance issues, that can create enormous problems for consumers and for investors," he said. 

One issue facing banks that want to custody crypto assets is the Securities and Exchange Commission's staff bulletin that requires most SEC registrants that hold crypto assets for their clients to record that risk on their balance sheets as a liability. For banks, that would mean they need to hold assets to offset that liability, an issue that's come up in BNY Mellon's announcement that it wants to custody crypto assets for some clients. 

In response to another question from Toomey, Barr said that while very few banking institutions are seeking to engage in custody activity, the Fed is requiring all of its regulated financial institutions to comply with accounting rules, including the SEC's interpretations of those rules. 

"That differential would impact bank decision-making," Barr said. 

The hearing also came a day after President Biden announced his intent to nominate Gruenberg for the FDIC chair, a position he's held in an acting capacity since February. 

Sen. Sherrod Brown, D-Ohio, who leads the committee, said that he "looks forward" to holding a hearing "in the next few weeks," for Gruenberg and the slate of Republicans for their mandated seats on the FDIC board. 

While Toomey didn't take the opportunity to oppose Gruenberg's nomination, Sen. Thom Tillis, R-N.C., hinted at possible Republican opposition to the nomination by noting concern over the partisan fight that led to the departure of former Chair Jelena McWilliams.