June 25, 2018

FCA on Crypto: Just say no.

Because it's Sunday, I thought I'd write a missive on that favourite depressing topic, the current trend of the British nation to practice economic self-immolation. I speak of course of the FCA's letter to the CEO.

Some many may be bemused and think that this letter shows signs of progress. No such. What the letter literally is, is the publication of a hitherto secret order sent to CEOs of banks to not bank crypto.

The instruction was delivered some time ago. Verbally. And deniably. The banks knew it, the FCA knew it, but all denied it unless under condition of confidentiality or alcohol.

Which put the FCA, the banks, and Britain into considerable difficulties - the FCA could neither move forward to adjust because there was no position to adjust, the British banks could not bank crypto because they were under instruction, and the British crypto-using public either got screwed by the banks or they left the country for Europe and places further afield.

(Oddly, it turns out that Berlin is the major beneficiary here, but that's a salacious distraction.)

After some pressure as the 'star chamber' process of business policy, it transpires a week ago that the FCA has come out of the cold and issued the actual instruction in writing. This is now sufficient to replace the secret instruction, so it represents a movement of sorts. We can now at least openly debate it.

However the message has not changed. To understand this, one has to read the entire letter and also has to know quite a lot about banks, compliance and the fine art of nah-saying while appearing to be encouraging.

The tone is set early on:


As evidence emerges of the scope for cryptoassets1 to be used for criminal purposes, I am writing regarding good practice for how banks handle the financial crime risks posed by these products.

There are many non-criminal motives for using cryptoassets.

It's all about financial crime. The assumption is that crypto is probably used for financial crime, and the banks' job is to stop that happening. Which would logically set a pretty high bar because (like money, which is also used for financial crime) the use of crypto (money) by customers is generally opaque to the bank. But banks are used to being the frontline soldiers in the war on finance, so they will not notice a change here.

The problem is of course that it simply doesn't work. The bank can't see what you are doing with crypto, so what to do? When the banks ask customers what they do with the money, costs sky rocket, but the quality of the information doesn't increase.

There is therefore only one equilibrium in this mathematical puzzle that the FCA has set the banks: Just say no. Shut down any account that uses crypto. Because we will hold you for it and we will insist on no failures.

Now, if it was just that, a dismal letter conflating crime with business, one could argue the toss. But the letter goes on. Here's the smoking gun:

Following a risk-based approach does not mean banks should approach all clients operating in these activities in the same way. Instead, we expect banks to recognise that the risk associated with different business relationships in a single broad category can vary, and to manage those risks appropriately.

The risk-based approach!

Once that comes into play, what the bank reads is that they are technically permitted to use crypto, but they are strictly liable if it goes wrong. Because they've been told to do their risk analysis, and they've done their risk analysis, and therefore the risks are analysed which conflates with reduced to zero.

Which means, they can only touch crypto if they know . This knowledge being full knowledge not that other long-running joke called KYC. Banks must know that the crypto is all and totally bona fide.

But they generally have no such tool over customers, because (a) they are bankers and if they had such a tool (b) they wouldn't be bankers, they would be customers.

(NB., to those who know their history, anglo-world banks used to know their customers' business quite well. But that went the way of the local branch manager and the dodo. It was all replaced by online, national computer networks, and now AIs that do not manifestly know anything other than how to spit out false positives. NB2 - this really only refers to the anglo world being UK, USA, AU, CAN, NZ and the smaller followers. Continental banking and other places follow a different path.)

Back to today. The upshot of the relationship for regulator-bank in the anglo world is this: "risk-based analysis" is code for "if you get it wrong, you're screwed." Which latter part is code for fines and so forth.

So what is the significance of this, other than the British policy of not doing crypto as a business line (something that Berlin, Gibraltar, Malta, Bermuda and others are smiling about)? It's actually much more devastating that one would think.

It's not about just crypto. As a society, we don't care about crypto more than as a toy for rich white boys to play at politics and make money without actually doing anything. Fun for them, soap opera for observers but the hard work is elsewhere.

It's not in the crypto - it's in the compliance. As I wrote elsewhere, banks in the anglo world and their regulators are locked in a deadly embrace of compliance. It has gotten to the point where all banking product is now driven by compliance, and not by customer service, or by opportunity, or by new product.

In that missive on Identity written for R3's member banks, I made a startling claim:

FITS Ė the Financial Identity Trilemma Syndrome

If youíre suffering from FITS, if might be because of compliance. As discussed at length in the White Paper on Identity, McKinsey has called out costs of compliance as growing at 20% year on year. Meanwhile, the compliance issue has boxed in and dumbed down the security, and reduced the quality of the customer service. This is not just an unpleasantness for customers, itís a danger sign Ė if customers desert because of bad service, or banks shed to reduce risk of fines, then banks shrink, and in the current environment of delicate balance sheets, rising compliance costs and a recessionary economy, reduction in bank customer base is a life-threatening issue.

For those who are good with numbers, you'll pretty quickly realise that 20% is great if it is profits or revenues or margin or one of those positive numbers, but it's death if it is cost. And, compliance is *only a cost*. So, death.

Which led us to wonder how long this can go on?

(youtube, transcript) Cost to compliance now is about 30% Iíve heard, but you pick your own number. Who works at a bank? Nobody, okay. Thatís probably good news. [laughs] Whoís got a bank account? Iíve got bad news: if you do the compounding, in seven years you wonít have a bank accounts, because all the banks will be out of money. If you compound 30% forward by 20%, in seven years all of the money is consumed on compliance.

As I salaciously said at a recent Mattereum event on Identity, the British banks have 7 years before they die. That's assuming a 30% compliance cost today and 20% year on year increase. You could pick 5% now and 10% by 2020 as Duff & Phelps did which perversely seems more realistic as if the load is now 30% then banks are already dead, we don't need to wait until 100%. Either way, there is gloom and doom however society looks at it.

Now these are stupid numbers and bloody stupid predictions. The regulators are going to kill all the banks? Nah... that can only be believed with compelling evidence.

The FCA letter to the CEO is that compelling evidence. The FCA has doubled down on compliance. They have now, I suspect, achieved their 20% increase in compliance costs for this year, because now the banks must double down and test all accounts against crypto-closure policy. More.

We are one year closer to banking Armageddon - thanks, FCA.

What can we see here? Two things. Firstly, it cannot go on. Even Mark Carney must know that burning the banking village to save it is going to put Britain into the mother of all recessions. So they have to back off sometime, but when will that be? If I had to guess, it will be when major clients in the City of London desert the British banks, because no other message is heard in Whitehall or Threadneedle St. C.f., Brexit. Business itself isn't really listened to, or in the immortal words of the British Foreign Secretary,

Secondly, is it universal? No. There is a glimmer of hope. The major British banks cannot do crypto because the costs are asymmetric. But for a crypto bank that is constructed from ground up, within the FCA's impossible recipe, the costs are manageable. Such a bank would basically impose the crypto-compliance costs over all, so all must be in crypto. An equilibrium available to a specialist bank, not any high street dinosaur.

You might call that a silver lining. I call it a disaster. The regulators are hell bent on destroying the British economy by adding 20% extra compliance burden every year - note that they haven't begun to survey their costs, nor the costs to society.

After the collapse there will be green shoots, and we should cheer? Shoot me now.
Frankly, the broken window fallacy would be better than that process - we should just topple the banks with crypto right now and get the pain over with, because a fast transition is better than the FCA smothering the banks with compliance love.

But, obviously, the mandarins in Whitehall think differently. Watch the next seven years to learn how British people live in interesting times.

Posted by iang at June 25, 2018 07:02 AM

Within the EU framework as a citizen you could argue that the FCA measure of a wholesale no to crypto currencies is not proportionate nor in law nor in regulations.

But the UK citizens opted to get out the EU.

Posted by: Twan at July 11, 2018 05:38 AM

Indeed you could argue that, and could probably get away with that in European court where bank accounts must be provided, consumers have rights, and courts side with consumers whose rights are trampled.

But the British regulator will argue that the law backs them up, and the courts in Britain won't take on London.

Where the subtlety is coming from is that the British regulator has accepted the banks' anti-competitive behaviour - London is Britain is banking. So the banks and regulators will all agree that crypto is a threat and they don't want anything to do with it.

Once that agreement is found, the policy is crafted to suit the decision. That's what we see in the FCA letter, using the language of mandarins.

Sadly, what they don't realise is that they have sewn the seeds of disaster - decades ago, and now those plants are growing strongly. I actually think it is way past the possibility to put those weeds back in order - I expect British banking to collapse from the inside in the next decade. People will blame Brexit. But it's really well before then.

Posted by: Iang at July 21, 2018 03:16 AM
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