Private credit took the loans, stablecoins threaten the funding
Last year's GENIUS Act prohibited stablecoin issuers from paying interest to holders. But the law left a loophole that allows third parties, like Coinbase, to offer "rewards" for users that hold these tokens. Banks are pushing for the CLARITY Act, now in Congress, to close this loophole, arguing that paying yield on stablecoins could drive $6.6 trillion away from bank deposits. Banks risk losing a cheap source of funding while facing rising competition from non-bank institutions. Barring any collapse in the private credit market, yield-bearing stablecoins are more likely to accelerate the shift in how credit is funded rather than reduce its overall supply.
Although banks claim reducing deposits will limit the supply of credit, the 2008 crisis motivated a rethink of this intermediary theory of banking. The theory states that the government sets some reserve requirement on deposits and then banks lend out the rest. Under this theory, more deposits, or reserves, should lead to more lending as the reserve requirement no longer binds. But after 2008, the Fed flooded the system with reserves via quantitative easing (QE), yet lending remained sluggish. Banks wouldn't lend after the 2008 crisis because they couldn't find borrowers they deemed creditworthy. Many central banks, such as the Bank of England, now state that the story works in reverse: banks first make a loan and then credit the borrower's account via a deposit. Although loans and deposits increase simultaneously, loans are the driver.
Despite not driving lending decisions, deposits serve as a cheap way to fund banks' loans. The New York Fed argues that when rates rose in 2022, banks passed little of this interest to depositors because they had sufficient deposits to cover the loans they wanted to make. In other words, if banks spotted new lending opportunities, but were short on cash, they could have increased deposit rates.
Other than deposits, banks often use the shadow banking system to fund additional lending. Money market mutual funds, for instance, provide banks with funding via instruments like repo and commercial paper. In 2023, this "wholesale funding" backed over 20 percent of banks' assets. In short, banks can increase deposit rates or draw on shadow banks to raise funds for loans.
A deeper issue for banks is competition for loans, as non-bank institutions increasingly provide credit across the economy. In 2008, banks provided about 60 percent of home mortgages, but by 2024 they only made about 35 percent as companies such as Rocket Mortgage entered the market. Nearly a quarter of small businesses sought financing from online lenders in 2024. Private credit, which grew from $46 billion in 2000 to $1 trillion in 2023, increasingly provides loans for medium and large businesses. Banks now provide a smaller share of credit than they did 20 years ago.
While banks face strong competition from non-bank institutions, yield-bearing stablecoins threaten a cheap source of funding. Stablecoins may create new risks, and private credit has fewer backstops than banks, but absent any new crisis they are unlikely to reduce the supply of credit.