Stablecoins, Narrow Banking, and the Liquidity Blackhole

For over a century, monetary reformers have proposed versions of “narrow banking” – financial institutions that issue money but do not extend credit. From the Chicago Plan of the 1930s to modern proposals like The Narrow Bank (TNB), the idea has been simple: prevent bank runs and systemic risk by forcing money issuers to hold only safe, liquid assets like government debt.

But regulators have consistently rejected narrow banks.

Why? Because while safe in theory, they disrupt the credit-creation system at the center of modern banking. Narrow banks remove deposits from commercial banks, hoard risk-free collateral, and break the link between short-term liabilities and productive lending.

Ironically, crypto has now resurrected the narrow banking model in the form of fiat-backed stablecoins. Stablecoins behave almost identical to narrow bank liabilities: they are fully collateralized, instantly redeemable, and backed primarily by U.S. Treasuries.

source: https://home.treasury.gov/system/files/221/TBACCharge2Q22025.pdf

Following the banking collapses of the Great Depression, economists in the Chicago School proposed an idea of separating money creation from credit risk. Under the Chicago Plan (1933), banks would be required to hold 100% reserves against demand deposits. Loans would be made only from time deposits or equity capital, not from deposits used for payments.

The intent here was to eliminate bank runs and reduce financial instability. If banks couldn’t lend against deposits, they couldn’t fail due to liquidity misma

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