The Future of Money and Banking

The Federal Reserve’s quantitative tightening efforts are coming to an end, and the focus is shifting to bank lending as the major engine of economic growth in the U.S. Regulators should keep a close eye on where these dollars are going, as it will have a significant impact on the future of money and banking.

The End of Quantitative Tightening

As the Federal Reserve winds down its quantitative tightening and brings the balance-sheet runoff to an end, markets are already looking ahead to the next move. The Fed’s coming "reserve management purchases" of Treasuries have sparked debate about whether this will amount to QE-lite. However, a more important development has occurred, with the introduction of Executive Order 14178, "Strengthening American Leadership in Digital Financial Technology," and the House’s CBDC Anti-Surveillance State Act, H.R. 5403, which have effectively taken a U.S. central bank digital currency off the table, at least for now.

The Importance of Bank Lending

For the foreseeable future, whatever "digital dollar" system the U.S. builds will still live on commercial bank balance sheets and private dollar-backed stablecoins, not on a Fed app. This means that bank lending will play a crucial role in determining the direction of economic growth. The way supervisors and standard-setters shape bank lending, through risk weights, capital rules, tax treatment, and data requirements, will have a significant impact on growth and inequality.

The Uses of Bank Credit

There are three broad uses of bank credit: consumption credit, asset-market credit, and production credit. Consumption credit finances spending that is gone tomorrow, such as card balances, overdrafts, and buy now/pay later plans. Asset-market credit finances the purchase of existing houses, commercial buildings, and financial assets. Production credit, on the other hand, finances new capital formation, such as plant, equipment, infrastructure, and software that raise output per worker.

The Impact of Credit Composition

When a rising share of credit is steered into real estate and markets, asset-price booms and busts become more severe and long-run productivity growth slows, even if total credit growth is unchanged. This is because production credit is essential for expanding the productive frontier and raising living standards. Regulators should recognize that not all credit is created equal and that the same dollar of bank lending can either fuel speculative bidding for the same stock of assets or expand the productive frontier.

The Role of Regulators

Regulators do not sign loan documents, but they design the plumbing that nudges balance sheets in one direction or another. Under Basel-style frameworks, well-secured residential mortgage exposures and many real-estate loans attract significantly lower risk weights than unsecured or lightly collateralized loans to small and midsize firms with solid cash flows but little hard collateral. Regulators should review risk weights and capital buffers explicitly through a credit-composition lens and eliminate mechanical advantages for asset-market credit that are not clearly justified by loss experience.

Measuring Loan Purpose

To redirect credit towards productive activity, regulators can measure loan purpose consistently and publicly. Call reports and supervisory data should capture, in a comparable way across institutions, how much of each bank’s book goes to consumption, asset-market purchases, and productive capital formation. Regulators cannot redirect what they do not measure.

Publishing Credit-Composition Scorecards

Regulators can publish simple credit-composition scorecards alongside capital and liquidity metrics. When supervisory agencies report on the health of the system, they should not only show headline capital ratios and stress-test losses; they should also show whether the system is leaning more toward mortgages and securities or toward production loans.

Coordinating Tax, Accounting, and Prudential Rules

Regulators can coordinate tax, accounting, and prudential rules so they do not all lean in the same direction. Capital rules, tax incentives, loss-provisioning standards, and government guarantees now interact in ways that stack incentives under mortgages and securities. A cross-agency review could identify where modest adjustments would make it more neutral to lend to productive capacity rather than just to property.

Conclusion

The future of money and banking will be shaped by the direction of bank lending. Regulators have a rare opening to refocus on what they uniquely control and steer more credit towards productive activity. By measuring loan purpose, publishing credit-composition scorecards, reviewing risk weights, and coordinating tax, accounting, and prudential rules, regulators can create a more balanced system that supports economic growth and reduces inequality. Safety and soundness will always be the top priority, but within a safe system, regulators can make a significant impact by promoting productive credit and reducing the dominance of asset-market credit.