What Should Be Done About Deposit Subsidies?
The Rationale for a Bank Duty-to-Serve Mandate
Banks are special. Since the Founding, Congress and the states have recognized that economic growth requires reliable access to credit and a secure payments system.1 They understood the need for banks and assembled the legal scaffolding that allowed for a rapid proliferation of charters. However, regulation lagged, evolving in fits and starts that reflected the technological and institutional limits of the era. A lack of adequate safeguards and ongoing political battles led to frequent banking crises over the 19th and early 20th centuries. The system only assumed its modern shape in the aftermath of the Great Depression, when New Deal reforms paired an extensive safety net with much more robust supervision. Indeed, the formal powers regulators can exercise in a crisis are so expansive that the U.S. can be best described as having a hybrid banking system. On the one hand, banks are private corporations that seek to maximize returns on shareholders’ capital. On the other, they perform critical functions on behalf of the government and can be directed to act in the public interest during periods of stress.2
This “quasi-sovereign” role is most clear with respect to the money supply. Very little consists of physical currency directly issued by the Federal Reserve. Most is held as bank deposits, with payments then reflected as transfers among depositors. The guarantees extended as part of the hybrid system were intended to eliminate frictions in the payments system by convincing the public to treat their deposits as “money.”3 However, an unintended consequence was that it drove a spread between the resulting convenience yield deposits enjoy and banks’ alternative cost of debt. My previous article (Quantifying the Taxpayer Subsidy on Deposits) estimated that banks earn as much as $150Bn per annum (i.e., roughly 50% of industry earnings) from this spread, even after accounting for the cost of running the business. It’s one thing to know banks have access to a government backstop if there is a crisis, but quite another to realize it drives so much of their earnings. A modern fiat currency system is ultimately a covenant between the people and their government. The public shouldn’t be expected to pay for a service they themselves are providing.
Proposed Alternatives
This exploitation of a public resource by private businesses has prompted calls for root and branch reform to eliminate free riding. For example, some argue for shifting to a “narrow banking” model where deposits can only be used to fund safe assets (e.g., Treasury securities or central bank reserves).4 For these scholars, the goal is to eliminate the run risk inherent in using transaction deposits to fund long-term loan portfolios and limit banks’ ability to stretch their deposit guarantee to cover high-risk lending or capital markets activities.5 In contrast, Saule Omarova has argued for abandoning the hybrid model altogether, shifting deposit-taking to a “public bank” model. Her focus is less on limiting systemic risk and more on “democratizing” access to the banking system by lowering costs and improving access. In one specific variant, she suggested that the Federal Reserve offer deposit accounts directly to the public.
What narrow bank advocates neglect is the critical role government-backed deposits play in maintaining a reliable supply of credit. Because they are perceived as money, they can offer depositors the assurance of immediate access to cash while simultaneously providing banks with a stable and low-cost source of funding. This “maturity transformation” means banks can offer borrowers long-term fixed-rate loans with little concern as to interest rate and liquidity risk. It also lets them hold small-balance and other illiquid loans that couldn’t be readily financed in the capital markets. The benefit of deposit funding is especially important at times of stress when lenders’ access to wholesale funding may be in doubt. If banks didn’t have access to stable deposits, they would require some other form of guaranteed funding. Otherwise, the resulting credit crunch would throttle consumer spending, investment and employment. In other words, a narrow banking model doesn’t reduce taxpayer exposure; it just rearranges the ledger items.
Narrow banking proposals are often unclear about how they will address the subsidy issue. Some just assume competition will lead banks to pass through the after-expense earnings from their reserve assets to depositors. However, the convenience yield of deposits generates a pricing wedge relative to securities, one that is potentially larger than the cost of operating the bank. Paying depositors more than the market demands will drive substitution into deposits from other assets, inflating narrow bank balance sheets more than is necessary in a competitive market. Potential distortions can be avoided if banks only pay the convenience yield demanded by depositors. In a public bank model, this won’t result in a subsidy as any profits are returned to taxpayers. However, in a privately-owned model, eliminating subsidies would require some mechanism to capture those profits.6
An alternative approach from Lev Menand and Morgan Ricks addresses both these concerns. Their proposed “New National Banking System” leaves the deposit-taking function with banks but requires them to be rechartered as public utilities. It echoes narrow bank proposals in seeking to limit the use of deposits to support risky assets. An explicit goal of their proposal is to undo the post-1980 shift toward deregulation and restore the clarity of the New Deal regulatory framework. Utilities wouldn’t be allowed to own stocks or commodities, and the proposal anticipates that securities trading would be conducted by nonbank financial firms. These nonbank firms would be prohibited from issuing short-term, runnable debt and would instead rely entirely on long-term debt and equity raised from investors. Utilities could engage in permissible forms of lending (i.e., those promoting “productive ends”, including meeting the needs of low- and moderate-income borrowers in their communities) that would continue to benefit from a stable source of long-term funding. They address the subsidy issue directly by requiring any spread between the all-in cost of deposits and the alternative cost of debt to be conveyed to Treasury as a “franchise royalty.”
Menand and Ricks’ proposal is an important addition to the public debate that offers an elegant solution to the subsidy problem. Unfortunately, their desire to force a clear separation between the utilities and riskier activities is unworkable given current leverage levels in the economy. Form follows function, and the legal framework needs to reflect economic realities. In the immediate postwar period, the stock of household and noncorporate business debt was roughly at parity with bank deposits (Chart 1). Given the balance between less liquid loans and stable funding, it was possible to erect a high fence around the banking system while letting corporations and investors fend for themselves in the SEC-regulated capital markets. However, over the last fifty years, the supply of these illiquid loans has grown well beyond the capacity of the banking system and is now funded in the capital markets by nonbank intermediaries.
Chart 1: Bank Deposits vs. Household and Noncorporate Business Debt (% of GDP)
Source: Federal Reserve Z.1 and author’s calculations. Balances includes data for commercial banks, savings institutions and credit unions. Deposits are shown net of reserves as deposit inflows that result from the Fed’s creation of reserves are not available to fund lending.
While large portions of the long-term funding for this risk (e.g., GSE MBS and student loans held by the Department of Education) are protected by separate government guarantees, origination, aggregation and distribution activities are not. The legal and regulatory changes Menand and Ricks criticize did not cause the increase in financial instability we’ve seen since the ‘80s. Higher debt levels were driven mainly by changes in tax policy and the related rise in asset values. Policymakers weakened New Deal rules in a haphazard effort to accommodate a new environment where too much illiquid debt was chasing too few sources of stable funding. It is this imbalance that is the underlying cause of the liquidity shortfalls that drive systemic risk. If policymakers had sought to maintain the New Deal framework in the face of rapidly rising debt, the result would have been even greater instability (i.e., the cause of increased nonbank intermediation was “supply push”, not “demand pull”).
We are where we are, and it would be dangerous to narrow the regulatory perimeter as Menand and Ricks suggest when debt levels are so high. Restoring the clarity and simplicity of the New Deal structure is impossible unless we also reverse the post-1980 shift of resources from labor to capital that has inflated equity values and increased leverage (there is a link between “financialization” and inequality, but the causation flows in the opposite direction from how it’s usually depicted). This is highly unlikely absent a major rupture in the political system, one larger than just the normal rotation in the partisan balance. Even if such an effort were to succeed, it would only halt the accumulation of new debt. Unwinding existing balances would take decades given the long-term nature of most loans.
In the interim, nonbank intermediaries (e.g., the GSEs, nonbank mortgage lenders, automakers, independent broker dealers, etc.) depend on a flexible supply of short-term liquidity from insured banks to manage volatile origination volumes, hedge interest rate exposures and meet investor demands for secondary market liquidity. Cutting them off from bank liquidity would make their business models unworkable, disrupting the flow of credit that supports aggregate demand. As such, it’s a nonstarter politically: the revealed preference through multiple crises is that the safety net extends beyond the payments system to include supporting lending relied on by a critical mass of voters. Policymakers should publicly acknowledge this reality and design around it.
In theory, the perimeter could be left untouched, and policy could instead focus on eliminating deposit subsidies by imposing a franchise royalty. However, even this aspect of Menand and Ricks’ proposal would be controversial. The industry will decry what they would label as a devastating “tax”, dispute the details of whatever methodology is used to calculate assessments, and deploy armies of lobbyists and lawyers to block the move in Congress and/or tie it up in the courts.7 Banks might also argue that if they “paid in full” for the public goods they employ, they can abjure any requirement to serve the public interest. In short, waging a protracted political battle over recapturing subsidies puts the principle of a public service obligation at risk for an amount of money that, while certainly meaningful, is not decisive for the country’s fiscal trajectory. The status quo is unfair, and eliminating subsidies by charging banks outright may eventually be necessary, but the complications argue for pursuing an alternative approach.
A Duty-to-Serve Mandate is a More Realistic Alternative
Given the challenges connected with trying to eliminate deposit subsidies altogether, policymakers should focus instead on ensuring they are used to improve outcomes for the public. This would start with insisting on candor: given how much of banks’ earnings derive from taxpayer support, complaints about the costs of necessary regulation should be mocked loudly and often. Banks’ exclusive access to guaranteed liquidity from taxpayers is comparable to the way railroads, telephone companies and other “common carriers” benefit from access to various scarce public goods (e.g., radio spectrum).8 If banks want to profit from this access, their products should be available to the public at the “just, reasonable, and affordable rates” required of other common carriers. This can be best assured by subjecting banks to an explicit “duty-to-serve” mandate that ensures affordable access to bank accounts and other services. It would be akin to the one already applicable to the GSEs that ensures mortgage credit is available to support the purchase of manufactured housing, preserve affordable housing, and bolster lending in rural markets.
At the moment, access to the banking system suffers from significant gaps. Branch closures in lower-income neighborhoods have fed concerns about “banking deserts.” While the vast majority of Americans have a bank account, a significant percentage of lower-income households do not. According to the FDIC, in 2023 approximately 14% of households with annual incomes below $30,000 did not have a checking or savings account. These 3.3MM households represented the majority of the 5.6MM total that were “unbanked”. The reasons offered for not having an account often revolve around costs, with a third claiming the level or unpredictability of fees as the main cause. Overdraft/NSF fees have fallen in response to negative publicity and regulatory pressure, but in 2025 consumers still paid over $12Bn in aggregate deposit fees.9 Given how unpopular fees are, why are they such a mainstay of banks’ pricing structures? When challenged, defenders of the status quo claim fees are necessary to maintain a sufficient level of profitability, particularly for lower-balance customers who don’t produce meaningful net-interest revenue. This is a flimsy excuse, one that policymakers should reject.10
Instead, banks should be required to maintain an acceptable level of branch density and offer low-cost transaction accounts to all applicants residing within their footprints as a condition of their charter (this is an element of the Menand and Ricks proposal as well). The structure of these accounts should account for the struggles faced by households living paycheck to paycheck. Families with modest savings and inconsistent expenses will occasionally run short of cash, so even the most basic accounts should offer overdraft credit at reasonable interest rates. The industry has publicized its willingness to offer low-cost checking accounts (e.g., the “Bank On” program). However, despite offering relatively modest fees (e.g., a maximum $5 per month with no minimum balance), consumer uptake in this product has been limited. Only 23.2mm accounts have ever been opened, and the 14.3MM accounts open at the end of 2024 represented only $18.2Bn in deposits. Even if low-balance accounts represent only 5% of transaction balances, that would still indicate an addressable market of $300Bn that this specialized offering has failed to penetrate. Given the adverse consequences of late payment on rent or utility bills, depositors understandably place a premium on access to cash liquidity. Banks shouldn’t take advantage of that preference to extract excessive fees.
The implementation of a duty-to-serve mandate for deposit accounts should be accompanied by more vigorous enforcement of the Community Reinvestment Act (“CRA”) and other rules with respect to lending. Banks shouldn’t neglect credit-worthy borrowers who are seeking small-dollar unsecured credit, mortgages and other loans. Nor should they cross-subsidize their wealthy and corporate customers from excessive interest rates and fees imposed on vulnerable borrowers who lack viable alternatives. Trump’s proposal for a temporary 10% cap on credit card drew renewed attention to the excessive spreads card lenders earn from their subprime customers. If, for example, rates were capped at 18% in today’s rate environment, a reasonable estimate is that it would cost the industry no more than $14Bn per annum of net-interest revenue.11 Separately, when the CFPB presented its final rule on credit card late fees, it noted that those fees were approximately $14Bn in 2022. The implication is that the industry could cap credit card interest rates, waive deposit service charges and eliminate credit card late fees, all while suffering a combined revenue loss of less than $50Bn per annum. This is well below the estimated $200Bn pretax subsidy they receive on deposits. In practice, many fees apply universally, so it would probably cost banks far less than $50Bn to make their products affordable for their most vulnerable customers.
How Should a Duty-to-Serve Mandate be Implemented?
Ideally, a robust duty-to-serve mandate would be implemented through explicit new legislation. However, given the lack of bipartisan consensus when it comes to helping the disadvantaged, this would likely require an end to the filibuster or a 60-seat Senate Democratic majority. Of course, policy often evolves more elliptically, with major legislation codifying already existing regulatory standards. For example, when the FDIC Improvement Act of 1991 codified standards for “safety and soundness”, it built on decades of regulatory work to define practices that would violate an earlier statute's prohibition on “unsafe and unsound” practices. A similar dynamic could play out with respect to a duty-to-serve. The National Bank Act’s requirement that the OCC assure “fair access” to financial services, coupled with the Community Reinvestment Act’s finding that banks must demonstrate their “deposit facilities serve the convenience and needs of the communities”, signal a clear intent that chartered banks have a duty to meet the needs of the general public. Regulations that further elaborated that standard could serve as the basis for future confirmatory legislation.
Unfortunately, any effort to impose these regulations without industry buy-in will face immediate backlash and legal challenges that are likely to succeed given the current makeup of the federal courts. However, this need not be the end of the story. The post-Trump political environment will be volatile, and a more populist future Congress might consider more sweeping policies, including imposing a $100Bn+ deposit franchise royalty of the sort recommended by Menand and Ricks. Faced with that prospect, industry leaders may see the wisdom of engaging constructively, embracing a duty-to-serve mandate to stave off potentially more costly requirements. Both sides would avoid a protracted legal battle, industry would protect most of their legacy privileges, and policymakers will have established the principle that those privileges are earned through a more tangible commitment to serving the public.
Conclusion
We shouldn’t throw away the elegance of a hybrid banking model that underpins household and small/middle-market business lending, thereby sustaining the demand that supports employment. Maturity transformation conjures a public good out of thin air - this is a good thing! However, it gives rise to a subsidy, one that is difficult to quantify with precision but is large and benefits bank shareholders at the expense of taxpayers. A pragmatic strategy would avoid protracted fights about specific dollar amounts and instead prioritize the principle that universal service is a condition of a bank charter. Banks don’t have a viable business model absent taxpayer support, and this reality should be acknowledged through explicit duty-to-serve requirements. Indeed, simply having access to stable funding already gives banks a competitive advantage against nonbank lenders. Shareholders’ property rights shouldn’t be assumed to extend to that stable funding being available at a subsidized cost. A duty-to-serve mandate would force them to use a portion of the subsidy to provide universal, affordable access to bank accounts and lend money to creditworthy borrowers at a reasonable cost. It wouldn’t require banks to make any changes to their business models, other than to acknowledge the benefits and obligations that accrue from their charters. If they balk and use a sympathetic court system to resist change, Congress could always choose to impose a fairer system through legislation.
Having just lived through the monetary chaos of the Revolutionary War and Articles of Confederation, the Framers also understood the value of a reliable currency in supporting national security. The Constitution therefore grants Congress the exclusive power to “coin money” and otherwise regulate the money supply.
For example, the November 12, 2008, Interagency Statement on Meeting the Needs of Creditworthy Borrowers stated: “The agencies expect all banking organizations to fulfill their fundamental role in the economy as intermediaries of credit to businesses, consumers, and other creditworthy borrowers. Moreover, as a result of problems in financial markets, the economy will likely become increasingly reliant on banking organizations to provide credit formerly provided or facilitated by purchasers of securities. Lending to creditworthy borrowers provides sustainable returns for the lending organization and is constructive for the economy as a whole.”
See “An Interoperability Framework for Payment Systems” from Durfee, Lee, and Torregrossa: “The Federal Reserve Banks were created, at least in part, to reduce volatility and inefficiencies in the U.S. payment system by performing clearing and settlement functions. The Reserve Banks’ introduction into the payment system in the early twentieth century was accompanied by a statutory mandate to clear checks handled by Reserve Banks and drawn on depository institutions at par.”
Of course, this assumes the stock of safe assets exceeds the broad demand for money in the economy. This is not a problem at the moment, when a public debt exceeding $30Tn is far in excess of the money supply. However, in a circumstance where debt and deficits were materially reduced, a narrow banking model would be much more difficult to administer. One of the advantages of the existing system of “bank money” is that it leverages the natural circulation of funds in the economy, inserting a guarantee on deposits to eliminate payment frictions while avoiding a need to lend money to banks directly.
Until recently, the debate regarding a narrow banking model was entirely theoretical. However, passage of the GENIUS Act has made it a live issue. Leaving aside their use of blockchain technology to settle transactions, stablecoins are just another species of narrow banking. While currently used mostly in the context of crypto trading, the new legislation will let this product compete with traditional bank deposits for storing discretionary liquidity.
These dynamics are playing out in the stablecoin market. Demand for stablecoins is currently supported by the pass-through of interest on issuers’ reserve balances to exchanges, ultimately being expressed as “rewards” (yield) on stablecoin balances. However, if the GENIUS Act and associated regulations catalyze mass adoption of non-interest bearing stablecoins for settling non-crypto transactions, the result would be a windfall for issuers.
The FDIC’s assessment authority is constrained by what is necessary to maintain sufficient reserves in the Deposit Insurance Fund. Moving beyond the risk of loss and targeting the funding cost advantage deposits provide would therefore require a change of law. However, even if the law was changed, there would still be serious challenges to how it would be implemented. Menand and Ricks propose a benchmark formula based on asset durations, but these calculations are often ambiguous for amortizing and revolving loan portfolios. Any ambiguity as to how the deposit subsidy is defined in regulation will likely prompt protracted litigation.
See “The Finance Franchise” from Hockett and Omarova: “At its core, the modern financial system is effectively a public-private partnership that is most accurately, if unavoidably metaphorically, interpreted as a franchise arrangement. Pursuant to this arrangement, the sovereign public, as franchisor, effectively licenses private financial institutions, as franchisees, to dispense a vital and indefinitely extensible public resource: the sovereign’s full faith and credit”
The FDIC provides bulk downloads of Call Report Data. The RI Schedule breaks out consumer deposit fees by category: in 2025, aggregate overdraft fees were $6.2Bn, maintenance fees were $4.6Bn and ATM fees were $1.7Bn.
How banks arrive at their estimates of customer-level profitability is an open question. The growing use of computers in consumer banking has shifted the balance between fixed and variable expenses. Any measure of profitability at the customer level is increasingly a function of allocation methodologies which are based more on management philosophy than any hard and fast data. Moreover, while banks are expected to operate in a safe and sound manner (including retaining access to the capital markets by earning an adequate return on capital), this doesn’t mean that every customer must be equally profitable. Banks invest in business they deem strategic and delivering affordable access should be seen as an investment in maintaining the privileges of their charters. They shouldn’t be allowed to hind behind arbitrary cost allocations and profitability thresholds to effectively deny service within their communities.
Drechsler et al (2025) used Fed Y-14 data to produce an analysis of credit card profitability by FICO tier. Assuming $1.3Tn in average card balances and a benchmark interest rate of 4.0%, their NIM, fee, and expense data suggest an 18% cap would reduce the rates charged on 43% of outstanding balances with FICOs below 700. The average 2.44% reduction in interest rates would cost lenders approximately $13.7Bn per annum.