Federal Reserve economists warn: tokenizing deposits could drive up borrowing costs

Dallas Fed Research: Tokenized deposits may reduce U.S. banks 'long-term interest rate risk exposure by US$700 billion

Dallas Fed economists Rosie Levi and Srini Ramaswamy A research report released on August 25 pointed out that under a simulation scenario, tokenized deposits may reduce U.S. banks' ability to hold long-term interest rate risk by US$700 billion.

Summary

Dallas Fed economists estimate that a 10% increase in deposit interest rate sensitivity could reduce banks 'duration capacity by US$700 billion.

A 10% reduction in deposit maturity could reduce the maturity conversion ability of the entire banking system by approximately US$580 billion.

The above estimates measure ten-year equivalent interest rate exposure, rather than the size of deposits predicted to leave the banking system directly.

Tokenization may allow depositors and artificial intelligence agents to instantly transfer funds to banks that provide higher returns.

Possible countermeasures by banks include raising deposit rates, expanding liquidity buffers or increasing wholesale debt issuance.

This figure does not mean that US$700 billion in deposits is expected to leave banks, nor does it mean that the size of loans will decrease accordingly. It measures the likely decline in a bank's long-term risk appetite, expressed in terms of equivalent exposure to ten-year Treasurys.

The author also stated that his views should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.

What is a tokenized deposit? Bank currency linked

Tokenized deposits may reduce the stability of bank financing.

Tokenized deposits are ordinary commercial bank deposits represented on a blockchain or other distributed ledger. They can support automated payments, programmable transactions, and round-the-clock settlement while still being a liability of the issuing bank.

Its speed could weaken the actual obstacles to relative stability of deposits. Customers seeking higher returns may move money between different institutions faster than through many existing banking systems.

In-depth analysis

"Instant settlement will allow revenue-oriented deposit-holders to switch banks almost instantaneously," economists wrote.

Smart contracts can automatically transfer balances when another institution offers a better interest rate. In theory, intelligent AI agents could monitor yields and automatically initiate these transfers without requiring manual action by customers.

The authors did not predict how widely depositors would use such automation. They described large-scale adoption as uncertain and assessed what might occur under specific assumptions.

The $700 billion estimate measures duration capacity

Banks use relatively stable deposits to finance mortgages, commercial loans, securities and other long-term assets. Although customers can withdraw demand deposits at any time, the overall balance often remains in the bank for years.

This behavioral stability gives deposits an effective duration. Banks also measure deposit beta, which is the degree to which the interest rate paid by banks to customers, correlates with market interest rates.

Using the Federal Reserve's H.8 balance sheet data, economists estimate that as of July 15, Bank of America held approximately $7 trillion in long-term interest rate risk exposure. About US$5.8 trillion (80%) of this is supported by the duration characteristics of deposits other than large time deposits.

Their analysis found that assuming an average deposit maturity of four years, a 10% increase in deposit interest rate sensitivity could reduce banks 'duration risk capacity by US$700 billion.

Another scenario analysis showed that shortening the average maturity of deposits by 10% could reduce maturity conversion capabilities by approximately US$580 billion.

These are rough estimates based on hypothetical duration and overall balance sheet matching, and are not predictions of actual loan losses, deposit outflows or bank failures.

Banks may raise interest rates or hold more liquid assets

Banks can respond by offering higher deposit rates, reducing customers 'incentive to switch banks. This approach will increase financing costs and compress loan spreads.

Institutions can also hold more reserves and government securities than long-term loans. Another option is to issue additional term debt to maintain existing loan levels.

The authors estimate that a greater reliance on expensive wholesale debt "may adversely affect credit costs."

Studies using the Brazilian Pix system provide early comparisons. A study by the Central Bank of Brazil found that increased use of instant payments has led banks to hold more liquid assets, especially government bonds, while reducing the share of loans on their balance sheets.

Brazilian research results do not suggest that U.S. tokenized deposits will produce the same results. Pix is an instant payment network rather than a tokenized deposit system, and the two markets operate under different banking structures.

Bank of America continues to build tokenized network

Despite potential financing risks, large U.S. banks are still advancing the construction of tokenized deposit infrastructure. The clearing house announced the launch of a shared network that supports automated workflows, interoperability and round-the-clock settlement.

Bank of America, Citigroup, Bank of New York Mellon, Wells Fargo and other institutions support the project. According to previous reports, JPMorgan Chase and its main competitors are building a shared tokenized deposit infrastructure aimed at connecting blockchain activities with regulated commercial bank currencies.

Community and regional banks are also entering this space. 39 state banking associations recently established the Banking Chain Alliance with the goal of launching a national blockchain network in 2027.

The design of these networks will determine how easily deposits can be transferred between institutions. Interoperability can improve payments, but also intensify competition for deposit funds, making deposit behavior, liquidity rules and bank size differences core concerns for regulators.