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ECB paper explores (un)attractiveness of stablecoin deposits for banks
August 03, 2024
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The European Union’s MiCA regulation requires stablecoin issuers to keep at least 30% of their reserves at banks, rising to 60% for significant stablecoins. This affects the revenues of stablecoin issuers because banks don’t pay much compared to the yield on investing in short dated government bonds. From the bank’s perspective, MiCAR looks like a good deal because it’s an alternative source of funding. However, a recent paper by a European Central Bank (ECB) economist explores how stablecoin deposits could be rather unattractive for many banks, and potentially attractive to others.

The author looks at it from the perspective of the Basel Committee rules for banks (unrelated to the Basel crypto rules).

As we’ll show, banks taking on stablecoin deposits are likely to have to park 100% of the funds in high quality liquid assets (HQLA). One of the interesting conclusions is that regulators could incentivize banks taking on stablecoin deposits to put the funds at the central bank rather than elsewhere.

Liquidity Coverage Ratio (LCR) & the SVB collapse

After the great financial crisis, the Basel Committee concluded that banks need to have more liquid assets on hand to support a sudden outflow of deposits, so it introduced a liquidity coverage ratio (LCR). The crux of the concept is straightforward – banks need to predict the net outflow of deposits within the next 30 days, and make sure they have at least 100% coverage in high quality liquid assets.

For typical retail insured deposits, it’s assumed that 5% will flow out in the next 30 days, rising to 10% for uninsured deposits. For not-so-small corporates, which made up a large proportion of Silicon Valley Bank’s (SVB) clients, the outflow is assumed to be 20%-40% during a 30 day period.

The collapse of SVB showed the LCR appears rather relaxed in the internet era. SVB had an 85% outflow in just two days.

Stablecoins and the LCR

There’s no explicit rule on how to treat stablecoin deposits for LCR purposes, but there are two potential options. Most funds from financial institutions are treated as flighty wholesale deposits with 100% out flows in the next 30 days. Alternatively, there is a classification for (securities) custody and clearing relationships, which ranks as a 25% outflow. It’s not straightforward to qualify for this lower rate.

If one classes a stablecoin’s deposits at the lower rate, taking on stablecoin deposits would be positive for a bank’s liquidity coverage ratio. If they are treated as a 100% likely outflow, it’s quite negative for the liquidity coverage ratio.

For example, if a bank starts with $1 billion in retail deposits, its expected outflows in 30 days would be $50 million (5%). If it had $75 million in HQLA, its LCR is 75/50 or 150%, significantly above the minimum 100%. If it takes on $100 million in stablecoin deposits, which it parks at the central bank, it now has $175 million in HQLA. But its 30 day net outflow is $150 million. So its LCR is now 175/150 or 116%, a substantial decline for a 10% bump in deposits.

Hence, unless the bank has an LCR buffer, it might need to increase its HQLA by more than 100%. This reduces its ability to earn a higher rate of return on other activities, such as lending.

As the ECB author stated, stablecoin deposits “inflate a bank’s balance sheet without providing resources it can use for lending activities and, under a high-stress scenario, they could exit the bank entirely.”

Banks that have high LCR buffers might be happy to take on stablecoin deposits. For banks without high buffers, stablecoin deposits may be unattractive.

Impact on balance sheet ratios

Apart from the LCR, Basel has two relevant balance sheet ratios, one related to risk weighted assets and the other to leverage.

The leverage ratio is the Tier 1 capital divided by total exposures. In a similar manner to the LCR, when a bank takes on stablecoin deposits, its leverage ratio gets weaker, assuming its Tier 1 capital is constant. Hence, stablecoin deposits will prove unattractive to banks that are constrained by the leverage ratio.

Stablecoin deposits don’t impact a bank’s risk weighted asset ratio.

Banks tend to be constrained either by the leverage ratio or the risk weighted asset ratio. If they are constrained by the risk weighted asset ratio, they might be more amenable to take on stablecoin issuers as clients, given stablecoin deposits don’t have a negative impact.

Incentivizing banks to deposit at the central bank

The ECB paper highlights that some jurisdictions allow central bank reserves to be excluded from the leverage ratio calculation. In that scenario, if a bank takes on stablecoin deposits and sticks the funds in government bonds, the leverage ratio is weakened. Instead, if it deposits the funds at the central bank, there is no impact on the leverage ratio. [These are not ring-fenced against the stablecoins, they are general reserves.]

We’d note that if stablecoins grow significantly, this could become a contentious issue as some governments might be keen for the stablecoin funds to be parked in Treasuries. It creates competition between supposedly independent central banks and the government.

We’d also note that in the United States, BNY Mellon is one of the main cash custodians for the USDC stablecoin. US custodian banks don’t count central bank deposits in their leverage ratios.

In conclusion, Europe’s stablecoin regime is already hard for issuers because of the large proportion of assets issuers must deposit at banks. This doesn’t just reduce their revenues, it also makes it tricky to find banking partners because a single bank can only make up 5-15% of reserves or 25% if it’s a systemically important bank. Additionally, stablecoin deposits cannot exceed 1.5% of a bank’s total assets.

If you add the LCR and leverage ratio issues, it seems like yet another hurdle. While Treasuries have their own drawbacks as stablecoin reserves from a financial stability perspective, they seem simpler.

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