Misallocated Regulatory Focus: The Systemic Risks of Under-Regulated Banking and Over-Scrutinized Crypto

The global financial system is at a crossroads, with regulatory focus increasingly misallocated between traditional banking and the crypto sector. While traditional banks face systemic under-regulation—exacerbated by unresolved vulnerabilities—cryptocurrencies are subjected to over-scrutiny that risks stifling innovation. This imbalance creates a paradox: one sector is dangerously exposed to instability, while the other is shackled by excessive caution.

The Under-Regulated Traditional Banking System

Recent banking crises, such as the 2023 collapses of Silicon Valley Bank, Signature Bank, and First Republic Bank, underscore the fragility of traditional banking systems. These failures were driven by liquidity risks, poor capital management, and regulatory gaps, particularly in the U.S., where partial deregulation contrasts with global trends toward stricter oversight [1]. For example, SVB’s reliance on uninsured deposits and its exemption from certain liquidity regulations left it vulnerable to rapid depositor withdrawals when interest rates surged [3].

Post-Global Financial Crisis (GFC) reforms like Basel III and the EU’s CRR 3 have pushed banks to adopt integrated risk models and real-time data frameworks [1]. However, these measures remain insufficient to address emerging threats such as cyberattacks, AI-driven governance challenges, and the risks of commercial real estate portfolios [2]. The 2023 turmoil revealed that even with post-GFC reforms, traditional banks lack the resilience to withstand macroeconomic shocks, particularly in a post-pandemic environment marked by digital transformation and non-bank financial intermediaries [3].

The Over-Scrutinized Crypto Sector

In contrast, the crypto sector is being regulated with a level of intensity that often ignores its nascent stage. While traditional banks operate under mature frameworks, crypto platforms face fragmented and evolving rules, such as the U.S. SEC’s "Project Crypto" and the EU’s MiCA framework [2]. These regulations aim to address consumer protection, anti-money laundering (AML), and environmental concerns but often lack nuance for the sector’s unique risks, such as volatility and decentralized governance [1].

The 2025 regulatory shift—exemplified by the U.S. OCC lifting restrictions on banks’ crypto engagement—signals a move toward integration [3]. Yet, this transition introduces compliance challenges, as institutions must navigate advanced blockchain analytics and AML frameworks [3]. Meanwhile, the Bank for International Settlements (BIS) envisions a next-generation monetary system leveraging tokenisation to unify central bank reserves and commercial bank money [4]. However, such innovation is hampered by regulatory overreach, which prioritizes caution over experimentation.

Implications for Investors

The misallocation of regulatory focus has profound implications for investors. Traditional banks, under-regulated and exposed to systemic risks, remain vulnerable to crises that could erode trust in the financial system. Conversely, the crypto sector’s over-scrutiny may deter innovation, delaying the realization of blockchain’s potential in areas like cross-border payments and asset tokenisation [4].

Investors must weigh these dynamics carefully. While traditional banking offers stability, its under-regulation poses long-term risks. Meanwhile, crypto’s regulatory hurdles create uncertainty but also opportunities for early adopters who can navigate compliance challenges. A balanced approach—supporting innovation in crypto while strengthening oversight in traditional banking—is essential to mitigate misallocation and foster a resilient financial ecosystem.

Source:[1] Three Financial Crises and Lessons for the Future [2] Regulatory landscape of blockchain assets: Analyzing the [3] How regulatory shifts are redefining the future of banking and crypto [4] III. The next-generation monetary and financial system