BREAKINGVIEWS-Why US banks' stablecoin pleading is flawed

By Stephen Gandel

NEW YORK, Feb 13 (Reuters Breakingviews) - After years of whining about regulation, bankers now want tight restrictions slapped on a fast-growing rival. Leading lenders like Bank of America’s BAC.N CEO Brian Moynihan have warned, citing a study, that $6 trillion of deposits could leave the sector for stablecoins, if these dollar-pegged tokens are allowed to pay interest to holders indirectly. The threat is real, even if it's not precisely what the banks say it is. But encouraging more competition for savers' money may be no bad thing.

For ages, consumers only had two places to put their cash savings – banks or mattresses. Money market funds (MMFs), starting in the 1970s, changed that. By parking customers' money in low-risk government and corporate debt securities, these products could pay a decent yield while offering savers ready access to their funds. The problem is that the cash held in MMFs lacks utility, meaning that users can only spend it if they withdraw.

Stablecoins, like Circle's $70 billion USDC, in theory combine the best of all worlds. These digital tokens are pegged to the greenback and backed by reserves like short-term U.S. Treasury bills or insured bank deposits. They're still relatively young, but could in theory be used for consumer payments. And while directly paying interest to holders is banned under the 2025 Genius Act, the industry has found a workaround through third parties like exchanges. USDC issuer Circle Internet CRCL.N, for instance, does not pay holders any money. But the $41 billion exchange Coinbase COIN.O does, to the tune of about 3.5% annualized, as long as users meet criteria like keeping their USDC balance on the trading platform. Circle in turn pays Coinbase a fee for custody and other services related to USDC, effectively subsidizing the interest that holders receive.

To banks, this is simply a loophole – and therefore a violation of the spirit of the Genius Act. They argue that if stablecoins can indirectly pay interest, customers will pull their money from traditional lenders, in turn stopping banks from advancing credit to households and small businesses. There is support for this view on both sides of the aisle. Aaron Klein, a former Obama administration Treasury official, wrote in September that interest-paying stablecoins could "cause massive problems resulting in losses by retail crypto holders, a bailout of big crypto, or a financial crisis.” A bill that might have closed the loophole stalled in the Senate in January, after Coinbase CEO Brian Armstrong said he opposed the legislation. The White House has given banks and the crypto industry until the end of February to find common ground.

Old-school lenders are right to be on high alert. Their model involves paying less on checking and savings accounts than they can earn on loans, Treasury bills or Federal Reserve balances. There's evidence that everyday Americans do particularly badly from this arrangement. In the March 2022 to March 2024 hiking cycle, for example, banks passed on just 40% of the increase in interest rates to retail depositors, according to Fed figures, compared with 60%-80% for business customers, depending on the deposit type. An explosion of yield-bearing tokens would bring new competition, especially if retailers like Walmart or Amazon.com get involved. Grocers and e-commerce firms stand to save on card fees if stablecoin payments proliferate, meaning they have an incentive to pay handsome yields to win customers over.

A lot depends on how big the digital tokens get. The $6 trillion figure, cited by BofA's Moynihan and others, comes from an April study funded by the Treasury Department. Others have come up with lower estimates. Fed economist Jessie Wang in December used a high-end possible figure of around $1 trillion. Last month, research analysts at Standard Chartered estimated that $500 billion could leave developed-market banks for stablecoins by the end of 2028. Yet Circle's New York-listed stock, which is down 64% in the past six months, implies that public-market investors are growing weary of giant stablecoin forecasts.

The first problem with the banks' argument is that it's not possible to pull deposits from the system on aggregate. Cash that goes to a stablecoin doesn't simply disappear – it goes into the reserve assets like Treasury bills or bank accounts. Imagine that a retail customer takes money out of Bank A to buy a new digital token. To use a stylized example, the stablecoin issuer would effectively use the new money to go out and buy Treasury bills. Whoever sold the government debt would now have extra cash in their account at Bank B. The money simply transforms from a retail deposit at Bank A into a wholesale deposit at Bank B. It doesn't leave the system.

It is true, however, that stablecoins could force individual banks to pay more to keep customer cash. But for most lenders, it's no deathknell. Breakingviews studied regulatory filings known as call reports, which include financial information for thousands of U.S. banks. For the 4,088 that made a profit last year, only 174 would fall into the red if they had to pay 1 percentage point more for consumer deposits, according to Breakingviews calculations. This cohort is composed of minnows, with a collective $79 billion in deposits. That's less than 0.5% of the total $19 trillion U.S. deposit base, according to data from KBRA Financial Intelligence.

Granted, a separate question is how many lenders would still be able to earn a 10% return on equity in this scenario. That's the level of profitability that generally counts as the minimum level for long-term viability. About 2,600 American banks currently have double-digit returns. That would drop to 1,600 if all of them had to increase interest on consumer deposits by 1 percentage point, implying that 1,000 mostly smaller lenders would have to switch their model or sell themselves. That would still leave the U.S. with far more banks than most developed countries. And since the level of the deposits in the system shouldn't change on aggregate, nor should levels of lending.

Many economists have argued that stablecoins are fragile and will only make the system less safe. But that's a separate, and much broader issue to the current debate around third-party interest payments. If the digital tokens are unsafe and prone to runs, the right answer is more bank-like prudential regulation, rather than rules designed to make the tokens arbitrarily less appealing.

The banking sector survived the advent of MMFs, even if many smaller regional lenders didn't. And savers are much better off for it. The same may be true if stablecoins take off.

Follow Stephen Gandel on LinkedIn and X.