There are essentially three reasons banks are different than gas stations – not counting the fact that banks make less of a mess. These are: 1) the ability to take FDIC-insured deposits and the cheap funding they provide; 2) access to the Fed’s discount window and resulting resilience; and 3) access to the payment system and the dominance in every sector in which this counts. Due to the high cost of regulation – warranted or not, it’s expensive – and the swift pace of innovation, the value of the first two benefits sharply eroded over the last few years. With its new proposal on payment-system access, the Fed contemplates taking away the third. If it does, I doubt the Fed will much like the financial system it accidentally creates as a byproduct of its own search for a payment empire.
As detailed in our forthcoming in-depth report, the Fed’s proposal reverses the Board’s policy when it rolled out the new instant payment-system framework in 2020. Then, it rejected tech-platform company pleas for access; now, it’s clearly open to them and other nonbank comers as long as Reserve Banks reassure the Board that the payor is pristine. The Fed of course acknowledges statutory limits on payment-system access, but now reads them far more generously than past statements presaged.
Why did the Fed reverse course and what does it mean to whom?
First, the Fed takes its institutional majesty very, very seriously. The more lugubrious its instant-payment rollout – and it’s slow and piecemeal – the more likely bank payors are to choose The Clearing House and for nonbank payors to build their own. Any reading of tech-platform power flashes red when it comes to their disruptive power. With this new proposal, the Fed is betting that, by opening its own payment system and governing those on it, it can preempt competitors that might range far more freely than the Fed thinks fit and proper.
Second, the Fed thinks its risk-management requirements along with a new policy on conditional access suffice to ensure payment-system certainty and finality. The statement mentions other goals – e.g., payment-system inclusion and efficiency – but only one – monetary-policy control – appears genuinely to worry it. This is of course a worry that takes one back to the first precondition for any Fed action: what the Fed thinks it does to the Fed. The Fed otherwise thinks it can manage nonbank payors up to and including giant tech companies by way of its risk restrictions, but this is as uncertain as its monetary-policy grip. I don’t share the Fed’s confidence in itself and thus recommend in my book that the nonbanks be given payment-system access only if they post sterile reserves in high-quality liquid assets equivalent to bank reserve balances – i.e., money on the counter.
What might the Fed’s confidence in itself mean for the future of the payment system and, in its wake, that of the construct of U.S. financial services?
Taking away still more of the once manifold benefits of being a bank of course means that being a bank is still less remunerative to its owners than being a nonbank in like-kind financial businesses, businesses which can then be made still more profitable than possible in a bank via integration into nonbank investment, telecommunications, and retail services. I’ve also written about the risks – especially for vulnerable households – resulting from such unregulated integration, but the Fed so far is unmoved. It thinks that as long as it controls the payment system, it controls the financial system. It won’t, but that’s what it thinks.
The Fed’s first mistake – maximizing its own objectives – result from its view that its own objectives are inextricably entwined with those of the financial system – in short, what’s good for the Fed is good for everyone else. Its second mistake is to assume that changing the terms of financial-system operation by virtue of new rules or, now, new payment-system access opportunity, does not fundamentally alter business models. Looking at cumulative totals – how much capital, how much revenue, what percentage of total financial services – the Fed is secure in its belief that banks will be banks even if being a bank is less profitable.
No bank manages itself this way because each bank knows that the total return figures by which investors judge it are the result of lots of individual business lines and operational decisions. Change even a little in one business line – see mortgages for just one case in point – and banks exit a business to concentrate on still more profitable ones. Conversely, grant nonbanks what the Fed may think a small edge warranted by greater efficiency and nonbanks will redefine key aspects of their business model to exploit every weak point in the banking sector their ruthless analytics can spot.
There are lots of them given all the regulatory costs banks bear to get the resilience in which the Fed takes such pride. If the Fed carves another, even bigger one, banking will change irreversibly and with it so also resilience as the Fed now understands it.