Fed Economists Warn Stablecoins May Reshape Credit Flows

A new research paper by a group of Federal Reserve Bank of New York economists examined how stablecoin deposits can affect the way credit flows through the U.S. financial system.

Banks that receive stablecoin deposits may need to maintain larger liquidity buffers and may hold a smaller share of assets in loans than their peers.

If stablecoins are able to divert funds from the traditional deposit base, it could potentially reduce the amount of funds banks have available to lend to consumers.

Fed Research Raises Questions About Lending Capacity

The New York Fed researchers analyzed how stablecoins interact with banks.

When customers convert traditional bank deposits into stablecoins, partner banks obtain large but highly volatile deposits associated with stablecoin creation and redemption.

They can move rapidly, increasing the potential for liquidity risk.

Partner banks exposed to these types of deposits are more likely to hold reserves and safe assets and reduce their ability to expand lending.

In practice, those deposits support less loan activity.

According to the paper, partner banks hold a smaller share of their assets as loans than their peers.

Financial economists often refer to this phenomenon as “disintermediation” of the financial system — in this case, the movement of money outside the normal pipeline of credit originated by banks.

“When you start to think about a traditional role of a stablecoin where you shove a bunch of money into a bank and create tokens that move around at light speed on top of it, you effectively disintermediate the payment rail from the underlying asset and lending rail,” FUTR Corp CEO Alex McDougall told us.

Stablecoins Do Not Create Credit the Way Banks Do

Banks fund loans based on deposits.

When consumers deposit money into their accounts, banks use some of that funding to create loans to households and businesses. Stablecoin issuers operate differently.

Most regulated stablecoins are backed by assets such as cash or short-term Treasury securities.

Issuers hold those assets to back the value of the tokens, not to fund loans to households and businesses.

Since those reserve assets are not loaned the broader economy, money that enters stablecoins may reduce the amount of funds flowing through the traditional bank loan-making process.

WalletConnect CEO Jess Houlgrave told us that “one of the most exciting things about blockchain-based payments is 24/7 instant settlement. Depending on the chain, payments can settle in minutes or seconds rather than hours or days.”

Credit May Move Further Toward Nonbank Lenders

If banks become more conservative with lending as deposit behavior changes, consumers may increasingly seek financing from nonbank creditors.

Fintech lenders generate about 42% of all new unsecured personal loans, according to recent TransUnion data.

Nonbank creditors (fintech platforms, specialty finance companies) often take the place of banks when banks limit lending criteria or withhold lending to higher-risk borrowers.

With a reduced amount of bank credit available, more consumers may opt for loans from online lenders and other nonbank creditors.

Greater competition for deposits may also cause funding costs to rise for those creditors that rely on warehouse lines or securitizations.

“The stablecoins we have today that are issued one-for-one by a private entity will likely be replaced for many users by tokenized deposits held directly by banks,” McDougall said.

What Stablecoin Growth Could Mean for Subprime Lenders

In periods of tighter funding conditions, community banks that rely almost exclusively on depositors tend to favor the financing of less risky loans than their commercial banking counterparts.

The impact of tightened funding conditions is likely to have an earlier effect on higher-risk consumers.

Consumers with lower credit scores may find fewer options if banks increase their conservatism (i.e., limit new lending) or if banks seek to move their balance sheet to safer asset classes.

For lenders that originate near-prime and subprime consumer credit, the dynamics described above can create an opportunity to expand the lender’s addressable market.

But lenders should pay close attention to the funding side of their operations.

The increasing use of stablecoins to compete for deposits may lead to increased borrowing costs throughout the entire lending ecosystem — particularly for those firms that use warehouse credit lines or securitize their lending activity.

Funding Pressures Could Rise Across Lending Ecosystem

Under such circumstances, firms that can secure stable funding and efficiently manage risk may be able to originate credit to consumers who can no longer receive credit from traditional banks.

If digital dollars disrupt the flow of deposits into and out of banks, the ripple effects may reach far beyond the confines of crypto markets — and into the competitive landscape for lenders that serve higher-risk consumers.