El Salvador’s plan to adopt Bitcoin as legal tender will pose an array of risks for banks doing business in that country, says Fitch Ratings.
In a new report, the rating agency said that the move to establish the cryptocurrency as legal tender in El Salvador will increase regulatory, financial and operational risks for financial institutions, “including the potential of violating international anti-money laundering (AML) and terrorist financing standards.”
Recently-passed legislation would require businesses to accept Bitcoin as payment alongside the U.S. dollar by Sept. 7 of this year, as long as they have the technology needed to process transactions.
Assuming that the plan to adopt Bitcoin goes ahead, “All existing obligations in the country may be payable in either bitcoin or U.S. dollars, including bank loans,” Fitch noted.
To prepare for this, the country must develop a regulatory framework for the cryptocurrency and systems for converting Bitcoin to dollars over the next few months, Fitch said.
While the government has pledged to create a Bitcoin-to-dollar conversion system, it’s not yet clear how this will work in practice, the report said — and that poses risks for banks.
“A rushed implementation of the new alternative payment system platform will affect financial institutions’ management framework for operational, cyber/ransomware, currency and liquidity risks, with additional implications for banks’ underwriting standards,” Fitch said.
Implementation issues aside, the move represents other risks to banks as well. In particular, money laundering risk may increase, given the lack of transparency in crypto transactions.
As a result, foreign banks may impose tougher tougher checks on their dealings with El Salvador’s financial institutions, especially “if regulations and controls are not robust enough to avoid tax evasion, money laundering and terrorist financing.”
Fitch noted that El Salvador does not yet meet Basel II or Basel III capital standards, or international accounting standards, “which increases the likelihood of an inadequate accounting and/or risk-management framework.”
Additionally, banks could face increased volatility in the value of their balance sheets due to their potential exposure to Bitcoin assets and liabilities, Fitch said.
While the actual adoption of the crypto may be limited by low levels of financial inclusion and internet access in El Salvador, Fitch also said that “capital gains will not be taxed and taxes can be paid in bitcoin, which could attract foreign inflows of Bitcoin to the country.”
“This may increase the risks that proceeds from illicit activities pass through the Salvadorean financial system,” the agency said.