The CFO Perspective on Digital Innovation

Periodically, the Federal reserve conducts a survey of senior financial officers (SFOs), to “gather views systematically from a number of banks on expectations for balance sheet management in the months ahead”. The survey is typically conducted to inform policy decisions on rates and balance sheet management, however the survey conducted in May and released earlier this month had a little easter egg for those interested in cryptocurrency, SFO views on digital innovation.

Digital innovation is a broad term, in the context of the SFO survey there were three questions:

1. What is the expected impact of distributed ledger technology (DLT) and crypto-related products and services as part of your bank’s growth and development strategy?

2. What is your institution's investment strategy for specific business lines as they relate to DLT and crypto-related products and services?

3. What is the expected impact of DLT or crypto-related activities on liquidity risk management activities?

Growth and Adoption of Crypto and DLT

While crypto and distributed ledger technologies evolve, adoption reaches a wider audience. In the short term 34 percent of respondents stated crypto was not a priority as it related to growth and development. This should come as no surprise, as an emerging market many institutions have yet to develop the infrastructure, policies, or expertise to support crypto activities. However, these same respondents do see the area as more impactful in the long term with only 18 percent of respondents stating crypto and DLT will not be a growth and development priority over the next two to five years.

At RiskScout, we’ve seen a similar trend with financial institutions whom we consult with. Many institutions not participating in the short term are actively developing a program and building expertise to prepare for the future impact of crypto and DLT. CFOs are actively monitoring and learning about crypto, with the Fed summarizing write in comments from respondents who stated “their bank is actively monitoring the situation and will adapt to the landscape as needed.”.

Crypto and DLT in Liquidity Risk Management

CFOs saw limited utility when it comes to crypto or DLT as a tool for liquidity risk management. Over the next 2 to five years, 63 percent of respondents found crypto or DLT unlikely to impact liquidity risk management practices. The Fed noted comments associated with this question indicated general uncertainty of plans relating to Crypto and DLT in liquidity risk management given the lack of regulatory guidance. At this point, DeFI protocols have limited utility for the CFO of a financial institution, they introduce unnecessary market risk (the risk of value changes in the underlying asset) as well as translation risk (the risk of converting the asset into another store of value). Without a crypto position for which market and liquidity risk needs to be managed, it is unnecessarily risky to introduce crypto products into a liquidity risk management program.

When we look to the long term (5-10 years) only 33 percent of respondents found DLT and crypto to not be important in liquidity risk management. My hypothesis is that senior financial officers are expecting this asset class to become more prevalent, and therefore would need to incorporate the technology to limit potential risks.

What does this all mean?

In the long term senior financial officers see crypto and DLT as important, if not imminent. And while guidance and regulation in the short term does not foster digital innovation, there is an expectation that the advent of more consistent rules will result in even broader adoption. Knowing that much of that regulation and research is already underway as a result of Joe Biden’s crypto executive order in March, it’s only a matter of time before there are clearer boundaries for financial institutions to operate within.[1]

[1] https://www.federalreserve.gov/data/sfos/files/senior-financial-officer-survey-202205.pdf

Senior Financial Officer Supporting Tables