Stablecoin Regulation: A Systemic Threat to U.S. Bank Funding and Monetary Policy

The debate over the Clarity Act is not merely about regulating a new financial product. It is a contest over the fundamental architecture of the U.S. financial system. The outcome will determine whether we see a managed evolution or a structural refactoring, with a potential outflow of up to $6 trillion in deposits threatening the bedrock of bank funding. This is a systemic risk of the highest order.

The scale of the potential disruption is staggering. Bank of America CEO Brian Moynihan has projected that if Congress allows interest-bearing stablecoins, as much as $6 trillion could flow out of the banking system-roughly 30% to 35% of total commercial bank deposits. This figure is not a guess but is grounded in a U.S. Treasury Department study that centers on the very legislative dispute now before Congress. The study's core concern is structural: stablecoins, in Moynihan's view, function like money market funds, parking reserves in short-term Treasuries rather than recycling them into loans to households and businesses. If this liquidity leaves the traditional banking sector, banks face a stark choice: either curtail lending or raise wholesale funding at a higher cost.

The current legislative status underscores the high stakes. The Senate Banking Committee had planned to take up the bill on January 15 but postponed the markup, citing the need for further discussion. This delay, while allowing more negotiation, also prolongs the uncertainty that could itself trigger market moves. The latest draft, introduced by Senator Tim Scott, attempts a compromise by banning passive interest on stablecoin balances while permitting activity-based rewards like staking. Yet, this very compromise has sparked fierce industry pushback, with Coinbase CEO Brian Armstrong stating the updated proposal is "significantly worse than the status quo" and withdrawing support.

Viewed another way, the Clarity Act debate is a referendum on the future of shadow banking. A ban on passive yield could slow the migration, but it may also accelerate the expansion of unregulated, activity-based financial products that operate outside traditional bank balance sheets. The $6 trillion projection, therefore, is not just a warning about bank deposits; it is a forecast of a financial system undergoing a profound, and potentially destabilizing, reallocation of capital. The coming weeks of negotiations will decide whether this refactoring is orderly or chaotic.

Mechanism: The Structural Disruption to Bank Funding and Credit Creation

The threat is not theoretical; it is a direct mechanical challenge to the core engine of bank lending. The traditional model relies on a stable base of low-cost deposits, which banks then recycle into loans. The emerging stablecoin model, however, operates on a fundamentally different principle. As Bank of America CEO Brian Moynihan has stated, many stablecoin structures resemble money market mutual funds, where the reserves backing the coins are typically parked in short-term U.S. Treasuries. This is the critical divergence: the liquidity is not being recycled into the economy via bank loans. Instead, it is being held as a safe, yield-bearing asset outside the traditional banking sector.

This creates a direct and potent competition for deposits. Interest-bearing stablecoins offer a product that functions like a bank account-providing a return for holding cash-but without the regulatory oversight, capital requirements, or federal deposit insurance that banks are subject to. In essence, they are a bank-like product operating in a shadow banking space. When consumers and businesses can earn a competitive yield elsewhere, the incentive to keep funds in traditional deposits diminishes. The potential scale is what makes this a systemic threat. Moynihan's projection of up to $6 trillion in deposits migrating into stablecoins represents a massive, sudden withdrawal of core funding from the banking system.

The consequence for credit creation is severe. If banks lose this low-cost deposit base, they face a stark choice. They can either significantly curtail their lending activities, which would directly constrain economic growth, or they can raise more expensive wholesale funding to replace the lost deposits. As Moynihan noted, alternative funding sources would likely come at a higher cost. This would squeeze bank net interest margins and could lead to tighter lending standards across the board. The transmission of monetary policy would also be impaired. The Federal Reserve's ability to influence the economy through interest rate changes relies on that rate signal being passed through to bank lending rates. If banks are forced to fund themselves at higher wholesale rates due to deposit outflows, they may be less willing or able to lower loan rates in response to a dovish policy shift, dampening the policy's effectiveness.

In short, the mechanism is a structural reallocation of liquidity. The $6 trillion outflow would not just reduce bank balance sheets; it would fundamentally alter the cost and availability of credit in the economy. The legislative debate over the Clarity Act is, at its heart, a fight over which financial architecture will dominate: one that channels savings into bank loans or one that channels them into short-term government debt held by stablecoin issuers. The outcome will determine the path of credit creation for years to come.

Financial and Systemic Implications: P&L, Valuation, and Shadow Banking

The $6 trillion deposit threat is not an abstract risk; it translates directly into concrete pressure on bank profitability and balance sheets. The core mechanism is a squeeze on the net interest margin (NIM), the primary driver of earnings for large lenders. As deposits flee, banks must either shrink their loan portfolios or replace the lost low-cost funding with more expensive wholesale sources. Both paths compress margins. The Treasury study cited by Moynihan and the Bank Policy Institute points to a similar scale of risk, warning of potential capital outflows of $6.6 trillion. This industry-wide consensus underscores that the threat is systemic, not isolated to one bank.

For valuation models, this structural shift demands a fundamental reassessment. The projected outflow implies a permanent reduction in the earnings power of the banking sector. A $6 trillion withdrawal from the deposit base would force a recalibration of asset quality metrics, as banks may be compelled to lend more aggressively to maintain revenue, potentially increasing credit risk. More broadly, the expansion of yield-bearing stablecoins accelerates the growth of unregulated shadow banking. These products mimic bank deposits but operate outside the traditional prudential safeguards, creating a parallel financial system. As JPMorgan's CFO noted, this is a "dangerous and undesirable" development that undermines the effectiveness of monetary policy. If the Fed lowers rates to stimulate growth, banks facing higher wholesale funding costs may be unable or unwilling to pass those cuts through to borrowers, dampening the policy's intended impact.

The bottom line is a re-pricing of financial stability. The current legislative debate over the Clarity Act is a fight over which architecture will dominate. A ban on passive yield may slow the migration, but it could also drive innovation into more complex, unregulated activity-based products. The $6 trillion projection is a warning of a financial system undergoing a profound reallocation of capital, with the cost of that transition already being baked into the P&L and valuation of the world's largest banks.

Catalysts, Scenarios, and What to Watch

The immediate catalyst is now in motion. The Senate Banking Committee's scheduled markup of the Clarity Act was postponed, but the clock is ticking. The committee must resolve intense disputes before the legislative window closes. The withdrawal of support from Coinbase CEO Brian Armstrong is a critical development. He stated the company cannot support the bill, citing a de facto ban on stablecoin rewards as a deal-breaker. This loss of a key industry backer raises the stakes and introduces significant uncertainty into the negotiation process.

The core battleground is the definition of permissible yield. The current draft, introduced by Senator Tim Scott, attempts a compromise by banning passive interest while allowing activity-based rewards like staking. This distinction is crucial. If the final text permits these activity-based incentives, it could still drive capital outflows, albeit through a different channel. The market will be watching for any amendments that could allow staking or liquidity provision rewards, as these would likely accelerate the migration of funds away from traditional deposits.

For investors and policymakers, monitoring a few key metrics will be essential. First, track bank deposit growth, particularly core deposits, for signs of acceleration. Second, watch for trends in bank net interest margins, which will be the first P&L indicator of funding pressure. Third, monitor the market share of interest-bearing stablecoins and the broader crypto market's capitalization, as these will signal the pace of the liquidity shift. The narrative will shift from legislative debate to real-time data as the bill progresses.

Two competing scenarios now define the path ahead. The first is a full ban on stablecoin yields, including activity-based rewards. This would mitigate the $6 trillion threat by slowing the migration, but it risks driving innovation and capital flight to more permissive jurisdictions. The second scenario is a permissive framework that allows activity-based rewards. This would likely accelerate the outflow, leading to the systemic refactoring of the financial system that banks fear. The outcome will determine whether the banking sector faces a managed, albeit painful, transition or a more chaotic reallocation of capital that reshapes credit creation for a generation.