Clients will today receive our in-depth analysis of the Fed’s proposal to radically realign access to the nation’s payment system. As we make clear, the Fed is eyeing a change many banks fear will put them at an acute competitive disadvantage. Ordinarily, this would slow the central bank. Now, not a bit, a sea-change from longstanding Fed thinking. If it lasts, banking will never be the same.
Is that all to the good? In the request for input on new payment accounts, the Fed says the following about what it has taken considered formulating these “skinny” payment accounts:
[T]he Board has considered the risks identified in the Guidelines (i.e., risks to the Reserve Banks, to the overall payment system, to financial stability, to the overall economy as a result of illicit activities, and to the implementation of monetary policy. In addition, the Board considered features that could limit Payment Accounts’ impact on the Federal Reserve’s balance sheet.
Did the Board just forget about banks? I don’t think so. Arguably, only captive regulators work to protect their charges from market forces. Market efficiency is enhanced if uncompetitive banks seek to clog the rails for low-cost, high-innovation services.
Or so it would be if this were a fair fight, which it isn’t. Banks are of course under an extensive – some might say crippling – set of prudential standards designed in part to ensure clearing-and-settlement capability. They are also key to financial intermediation. As we noted last week, a new FRB-NY study shows that old-school retail banks are the most important banks when it comes to robust, resilient economic growth. If their ability to provide payment services is impeded thanks to regulatory arbitrage, then intermediation takes a hit that will be felt quickly in the economy as a whole.
The Fed’s newfound focus on market discipline also seems to apply only when the Fed has comforted itself that nothing it proposes will damage anything it cares about. I have written before about how the Fed’s bloated balance sheet backstops $1.85 trillion of highly-leveraged Treasury obligations at Cayman Islands-domiciled hedge-funds. Why does the Fed think this more important than payment-system stability and sound financial intermediation? The answer is that it wants a big balance sheet so it can be sure nothing goes wrong in the Treasury market even though those who could do it harm are masterful exploiters of regulatory, sanctions, and tax loopholes. I could not agree more that coddling banks undermines economic efficiency and, ultimately, financial stability. But the Fed must ensure it isn’t coddling others with still less cause.
The central bank has to think about bank competitiveness because it and the other federal regulators – not impersonal market forces – determine banking-sector competitiveness. Does the central bank really want a banking system comprised largely of GSIBs and narrow-bank stablecoin issuers? It shouldn’t, but failing to think through payment-system redesign could well have this effect.