This past week, the CEOs of some of the largest U.S. banks attended Davos, and used the opportunity to attack Coinbase CEO, Brian Armstrong, for having the temerity to attempt to compete with them by offering stablecoin holders a much higher rate of interest than the pittance they pay on deposits.
At a time when affordability and the struggling finances of low- and middle-income Americans is at center stage politically, the debate over whether to rein in Coinbase’s ability to pay American consumers a high return on their savings is a golden opportunity for the Trump Administration to show the public that it cares about citizens, not fat cat bankers. Trump can and should prevent the so-called Clarity Act from reinforcing the misguided provision of the Genius Act that protects banks from competition by prohibiting interest payments on stablecoins.
That prohibition gave Coinbase an opportunity for regulatory arbitrage by offering interest on stablecoins placed on its platform. The Genius Act prohibition on interest payments is clearly contrary to the interests of consumers, and a sop to dinosaur bankers and their outdated approach to banking.
There is much at stake in allowing a blockchain-based stablecoin payment system to evolve as a means of transacting in everyday goods and services, and in securities markets. Stablecoins are a powerful transacting idea that could offer consumers a faster, safer, and more remunerative means of payment, backed by low-risk securities. As a result of the Genius Act, stablecoin issuers will be chartered and examined like banks, and they will be subject to prudential regulations. Because their securities holdings pay interest, in a competitive market, most of the interest they earn would be passed through to consumers. The Genius Act’s prohibition on that pass through at the behest of uncompetitive incumbent banks reflects the many regulatory burdens and operational inefficiencies that make it impossible for existing banks to offer similar rates of return on deposits (the “buggy whip” of the payments system that the incumbents offer).
It is telling for the big banks to admit publicly that the only way for them to survive under their current business model is for the government to prohibit anyone else from paying a decent return to consumers. Bankers understand that if stablecoins were allowed to pay interest, incumbent banks would lose deposits, which currently serve as a low-cost means of funding their lending and other operations. There is no doubt that if competition were allowed to occur, incumbents would continue to lose market share. But the cost to them should not be confused with a social cost.
The last twenty years have seen major technological changes in the processing of information, which have spurred the development of new non-bank lending platforms and new non-bank payments platforms. The two sets of innovations have occurred in separate intermediaries, and that fact is something policy makers should ponder. Traditional banks combine payments and lending as their core businesses, and many of us academics have for decades identified the potential synergies that come from doing so. But those synergy arguments are all about the economics of private (sometimes called asymmetric) information, and technological change has substantially reduced the importance of synergies.
One historically relevant argument for deposit-loan synergy (one that Charles Kahn and I demonstrated in a formal theoretical model in 1991) is that deposit funding of loans can be desirable as a means to discipline lenders (thereby encouraging proper management of loans) through the threat of speedy withdrawal. But that synergy argument only applies if the value of bank loan portfolios is hard for outsiders to determine based on publicly available information. Public information about borrowers has become much more available, both in the form of credit scores and evaluations of risk based on analysis of Big Data sets that cull news about borrowers from the web. The argument about combining deposits and loans to facilitate discipline, therefore, is less plausible than it once was. Furthermore, deposit insurance and additional too-big-to-fail protection have limited depositor losses, which curtails the incentive for depositors to discipline banks with the threat of withdrawal.
Legal innovation is also undermining the traditional synergy between managing payments and loans. The “open banking” laws sweeping the world – which have been delayed in taking effect in the U.S. due to big bank lobbying – would give any U.S. lender access to the payments records of a potential borrower, implying that the lender who manages a borrower’s payments has no information advantage in evaluating credit risk relative to other lenders not providing payment services.
In the absence of economies of scope that drive the bundling of bank activities, there is no social cost to allowing competition to force banks to shrink as new specialist intermediaries offering separate payment and lending services grow, which is why the competitive market outcome has been moving resources from bundled banks to specialized financial enterprises.
To ensure that these new sorts of intermediaries operate honestly and transparently it makes sense to modernize the national bank charter to permit them to be chartered as banks and be subject to examination and prudential regulation, as the Genius Act did. It does not make sense, however, to prohibit interest payments as a means of blocking efficient new forms of intermediation from competing with inefficient incumbents.
In addition to consumers’ benefits from higher interest rates on their transactions accounts and lower loan interest rates, the growth of unbundled banks and the shrinkage of the inefficient incumbents would have other major advantages. As the big banks shrink, the continuing social costs of their too-big-to-fail protection – which the 2008-2009 crisis illustrated – will also shrink.
Innovative intermediaries offer even more advantages. New lending platforms and payments mechanisms typically enjoy low overhead costs, which have proven to be especially beneficial for low-income consumers seeking to execute small lending or payment transactions. Innovative lenders have also found ways to gain the confidence of minority communities by offering credible third-party advice to consumers (in multiple languages), which attracts borrowers that often feel uncomfortable going into a bank to ask for a loan.
It is comical to witness the rich Davos crowd of buggy whip-purveying bankers begging for government protection as they pass the caviar, and it is high time for policy makers to reject their self-serving arguments and give competition a chance to benefit consumers.
