Fed’s Michael Barr Says Crypto Turmoil Highlights Potential Risks to Financial System

“Recent events in crypto markets have highlighted the risks associated with new asset classes when not accompanied by strong guardrails,” Mr. Barr told lawmakers. He didn’t identify any crypto companies by name.

Mr. Barr, in written testimony, said crypto-market meltdowns “remind us of the potential for systemic risk if interlinkages develop between the crypto system that exists today and the traditional financial system.”

In addition to Mr. Barr, Tuesday’s oversight hearing before the Senate Banking Committee included two other top banking regulators:

Michael Hsu,

the acting Comptroller of the Currency, and

Martin Gruenberg,

the acting head of the Federal Deposit Insurance Corp. The group is scheduled to testify again Wednesday before the House Financial Services Committee. The hearings were scheduled before FTX collapsed.

Ohio Sen.

Sherrod Brown,

the Democratic chairman of the Senate Banking Committee, said it was appropriate for regulators to treat crypto skeptically because such currencies have been used for speculation, fraud, sanctions evasion and theft.

“There doesn’t seem to be anything useful or beneficial that hundreds of speculative cryptocurrencies can be used for,” he said. “Private cryptocurrencies are not backed or protected by the government, and they shouldn’t be.”

Sen.

Pat Toomey

(R., Pa.) said crypto customers might be better protected were commercial banks allowed by their regulators to engage in more crypto activities, such as safeguarding digital assets alongside traditional investments. He criticized regulators for not providing banks with more guidance that would outline the types of permissible activities.

If banks can demonstrate that they can participate in the crypto space “in a safe, sound and fair manner, we’re all ears,” Mr. Hsu said.

Sen.

Cynthia Lummis

(R., Wyo.) said FTX’s collapse was “awful and simultaneously not all that surprising,” pointing to highly leveraged products it had previously offered mom-and-pop retail customers outside the U.S. She defended draft crypto legislation that she introduced earlier this year that she said would have imposed guardrails on the industry and prevented the collapse of FTX.

“It is obvious that Congress needs to regulate digital assets,” she said.

All three agencies are working together “to assess the risks and opportunities posed by a range of crypto-asset-related activities,” Mr. Barr said in his prepared remarks.

While the U.S. banking system emerged from the pandemic in strong financial health, the domestic economic outlook has weakened amid tighter financial conditions and increased uncertainty. As a result, the Fed will heighten its focus on liquidity, credit and interest-rate risks at the companies it oversees, Mr. Barr said.

“Uncertainty has led to increased financial market volatility and may also reveal pockets of excess leverage and liquidity risk in the nonbank financial sector, which risks spillovers to the banking system and the real economy,” he said in written remarks.

Tuesday’s hearing comes a day after the White House said it would nominate Mr. Gruenberg, a Democrat, to serve as the FDIC’s full-time leader, pairing his nomination with two Republican aides it nominated earlier in the fall. The law requires partisan balance on the five-member FDIC board, and the banking regulator currently has three Democrats and no Republicans.

Mr. Brown said he hoped to advance his nomination “as swiftly as possible.”

Write to Andrew Ackerman at andrew.ackerman@wsj.com