Community banks are key components of the U.S. payment system. Yet, although Congress is
Bills such as the Lummis-Gillibrand Payment Stablecoin Act and the Clarity for Payment Stablecoins Act (which passed the House Financial Services Committee on a bipartisan vote), however, would form a new regulatory regime for stablecoins that creates a new charter for issuers and allows banks and financial firms to issue stablecoins; limits stablecoins' reserve assets to high-quality liquid assets like Treasuries and short-maturity repos; and subjects issuers to banklike supervision. These bills would effectively treat stablecoins as deposits in narrow banks, just without the Federal Deposit Insurance Corp. coverage that is a hallmark of community bank marketing. And yes, stablecoins can offer yield, just like bank deposits and money market fund shares.
Enacting such legislation into law threatens to divert deposits away from community banks. To existing bank depositors with more than $250,000 in assets (that is, with accounts above the FDIC's insurance ceiling), stablecoin issuers will have a competitive advantage over traditional banks because investors will perceive those funds as safer as they are restricted only to high-quality liquid assets. In contrast, uninsured deposits are seen as riskier. To depositors below the deposit insurance ceiling, stablecoin issuers may still be more appealing if they can offer higher interest rates than banks — a real possibility, given that money market funds frequently offer higher rates than bank accounts. In addition, the economist Mark Flannery predicts that stablecoin legislation would cause total deposits in the banking system to fall as cash used to purchase Treasury bonds will leave the banking system. Others reject that assertion, but even if total deposits remain steady, they are liable to migrate to larger banks as the sellers of high-quality liquid assets are unlikely to be customers of community banks.
Stablecoin legislation also threatens community banks by increasing their costs. Community banks could, of course, mitigate this migration of depositor assets to stablecoins by paying higher interest rates than those offered by stablecoin issuers, but that would squeeze community banks' already-tight margins. At the same time, requiring stablecoins be backed only by high-quality liquid assets will increase costs to community banks that rely on those same assets for liquidity.
In a letter to Treasury Secretary Janet Yellen last week, the Massachusetts senator highlighted the growing use of cryptocurrencies by malicious organizations abroad and underscored the need for anti-money-laundering and counterterrorism provisions in future proposals.
Today, community banks have a competitive advantage over their nonbank competitors in that they can have Federal Reserve master accounts, allowing them to deposit customer assets with the central bank and facilitate cheap bank-to-bank payments. But there is no guarantee this state of affairs will continue: There is nothing in existing law that prohibits stablecoin issuers from receiving master accounts, nor do the legislative proposals under consideration contain that prohibition. At least one stablecoin bill would allow commercial firms to own stablecoin issuers, potentially opening the door to the likes of Walmart, Amazon and Meta receiving master accounts.
Although community banks would be permitted to issue their own stablecoins, this is unlikely to overcome stablecoins' competitive threat. Because stablecoins lack deposit insurance, customers are likely to demand stablecoins from only a few issuers who are "too big to fail." Today, a plethora of stablecoin issuers exist, but only six have over $1 billion in issued tokens and only one has over $100 billion. Stablecoins already benefit from network effects, and so the only beneficiaries of legislation legitimizing stablecoins are likely to be the largest institutions, such as JPMorgan Chase, Fidelity and Walmart.
Furthermore, proposed stablecoin legislation would prohibit community banks from competing with stablecoins on the terms most favorable to them: their community-based business models. The safest stablecoins are tokenized deposits, which are digital representations of FDIC-insured bank deposits that can be sent over blockchains. Because tokenized deposits are simply traditional bank deposits, community banks retain their competitive advantage as community-based institutions that reinvest in local borrowers. Although various groups, including the USDF Consortium and the Regulated Liability Network, are actively working to make tokenized deposits a reality, the legislation currently under consideration would have the result of outlawing them — tokenized deposits would be considered stablecoins under these bills and would be required to be backed by high-quality liquid assets.
Stablecoin legislation is a recipe for empowering the biggest of banks, brokers and commercial firms at the expense of community financial institutions. Despite this existential threat, community banks seem content to largely ignore stablecoins and the legislation legitimizing them. There has been no mass mobilization of community bankers to Washington, D.C., to speak with legislators on this topic. The 2024 lobbying priorities of community banks' trade association include pushing back against industrial loan companies and credit unions, but not this other competitor. So far, community banks appear to discount the danger they face from stablecoins. They do so at their own peril.
