Treasury's McKernan sees sea change in deposit behavior

• Key insight: Treasury Under Secretary for Domestic Finance Jonathan McKernan said in an appearance Tuesday that the low-cost, sticky deposit behavior that banking has become accustomed to may face pressure as fintechs gain more market share.  
• Expert quote: "We've had banks funded by … deposits, payment related liabilities: low interest, pretty sticky, generally speaking, long duration. Like it or not, technology is going to pressure that dynamic." — Treasury Under Secretary for Domestic Finance Jonathan McKernan
• What's at stake: McKernan said the Treasury Department is working to create a "level playing field" for banks and nonbanks to compete.

WASHINGTON — Treasury Under Secretary for Domestic Finance Jonathan McKernan said Tuesday that he fears one fundamental building block of the banking system — low-cost deposits — could be under renewed pressure from fintech challengers.

Speaking at an event hosted by the American Fintech Council Tuesday morning, McKernan — who was sworn into office on Oct. 7 — said he is broadly motivated by thinking creatively about "the financial system of the future," noting that the regulatory landscape over the last decade or more has pushed more and more traditional bank activity out of the banking sector. 

McKernan said that the increase of nonbank market share is not in itself a problem, except to the degree to which it is driven by regulatory arbitrage. But while the administration is working to make the bank compliance burden more comparable to those of nonbanks in the realms of capital and compliance, McKernan said, the nonbank sector may also be making inroads into banks' core deposits, posing another challenge to banks.

"We've had banks funded by — I call them, it's not the right term, but I call them payment-related liabilities. Deposits, payment-related liabilities: low interest, pretty sticky, generally speaking, long duration," McKernan said. "Like it or not, technology is going to pressure that dynamic, and to the extent, then, that the liability side is undergoing similar pressure that you have on the asset side of the banks — where the duration shortening, the cost is going up — that is a profound change in market structure. We need to think about the implications of that — the implications for consumers, for growth, credit, for maturity, liquidity, intermediation."

McKernan said that the administration has no vested interest in ensuring that banks outcompete their nonbank peers, but he warned that the marketplace competition between banks and nonbanks has favored nonbanks considerably in recent years. 

"If the nonbanks compete with the banks on a level playing field, and that's just where the intermediation ends up, great — that's an efficient American economy. But if we're driving intermediation by a regulatory arbitrage or otherwise to the nonbanks, this is a problem, right?" McKernan said. "Again, it's not our job to stand in the way of change. In fact, we should need to make sure that these are things that are driven by fundamentals and not by the regulatory framework. And also we are thinking ahead as to what that means for the financial system."

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McKernan added that these broader judgements about the financial system — who may participate in it, and under what rules — are important questions that have historically been shunted to the banking regulators. But under the second Trump administration, he said, there is more direct involvement from the White House and Congress in deciding how exactly banks and nonbanks should interact and compete.

"I think policymakers have tended to surrender these issues to the banking agencies, and these are questions that involve really important value judgments and tradeoffs and cannot be left to the technocrats," McKernan said. "They have a role to play here in advising on how to strike this balance, but ultimately, you need folks accountable to elected officials involved in striking this balance, thinking about what the financial system of the future should look like, and ensuring that the regulatory framework is aligned with that. These are very profound questions kind of being answered — or implicitly being answered by not being answered."

On the topic of the Fed's nascent "skinny" account proposal put forward in recent weeks by Federal Reserve Gov. Christopher Waller, McKernan said he was "intrigued" by the idea, which would allow banks ranked as "Tier 3" for master account consideration to gain a payments account with the Fed, allowing their access to the Fed's payment rails without also granting access to other benefits like the discount window or interest on reserves. Waller said last week that he is aiming for a final rule on Fed payments accounts by the end of next year. 

"I love the entrepreneurialness of the concept and I hope [the Fed] will take it very seriously; it deserves careful study. We've had this historic — let's call it a bundling — of payments with maturity and liquidity transformation, [and other master account benefits]," McKernan said. "I struggle to find in the theoretical literature a strong case for why we should legally mandate that bundling. That said, this has been a feature of the financial system for a long, long time, and I tend to approach things from a very cautious, careful, incremental perspective. So what is interesting … about Gov. Waller's proposal is that it is incremental in that direction. It doesn't go all the way, but it does take cautious, calibrated steps towards fostering innovation in the banking and payments system."