U.S. Community Banks Warn GENIUS Act Loophole Threatens Financial Stability

Community Banks Push Back on GENIUS Act Design

U.S. community banks are raising fresh alarms over the GENIUS Act, warning that a perceived loophole in the stablecoin law could undermine local banking, restrict credit, and threaten financial stability. In a letter sent to the Senate this week, the American Bankers Association’s Community Bankers Council argued that the legislation, while well-intentioned, may allow stablecoin issuers to indirectly pay yield to holders through crypto exchanges, bypassing the law’s core safeguards.

The GENIUS Act, passed last year, was designed to bring stablecoin issuers under a clear regulatory framework while preventing them from competing directly with traditional bank deposits. To achieve that, the law explicitly bans stablecoin issuers from paying interest or yield to holders. 

However, community bankers now argue that some crypto firms have found ways around this restriction by partnering with digital asset exchanges, which offer rewards tied to stablecoin balances. According to the council, this structure allows stablecoins to function like interest-bearing accounts, despite the intent of the legislation.

The concern is that this workaround could pull deposits away from community banks, reducing their ability to lend to households and small businesses that rely heavily on local credit.

Deposit Flight Could Weaken Local Lending

Banking groups warn that even modest deposit outflows can have outsized effects on community banks, which depend on stable deposits to fund mortgages, small business loans, and agricultural credit.

The Bank Policy Institute previously cautioned that the GENIUS Act could increase deposit flight risk, especially during periods of financial stress. Reduced deposits, the group noted, could lead to higher interest rates, tighter lending standards, and fewer loans across local economies.

According to estimates cited by the ABA, as much as $6.6 trillion in U.S. bank deposits could be exposed to competition from stablecoins if the issue is left unresolved.

Crypto Industry Fires Back

Crypto firms strongly reject the idea that the GENIUS Act contains a loophole. Paul Grewal, chief legal officer of Coinbase, dismissed the claims outright, stating:

Industry groups argue that stablecoins are payment tools, not lending instruments, and that banning exchange-based rewards would stifle innovation and limit consumer choice without meaningfully strengthening bank safety.

The Crypto Council for Innovation and the Blockchain Association echoed that position in prior letters to lawmakers, warning that additional restrictions would slow U.S. competitiveness in digital payments.

Banks Say Crypto Can’t Replace FDIC-Backed Lending

Community bankers counter that crypto firms and exchanges cannot replace the role of banks, particularly because they do not offer FDIC-insured deposits or provide relationship-based lending in local communities.

The ABA argues that stablecoin issuers are not structured to absorb shocks, manage credit cycles, or support small-business lending during downturns. In their view, allowing stablecoins to behave like yield-bearing accounts risks shifting funds into instruments that don’t support the real economy.

They also warned that illicit actors could still exploit gaps in the system using unhosted or offshore wallets, regardless of stablecoin restrictions.

FDIC Moves Forward With GENIUS Act Implementation

Despite the debate, regulators are already advancing implementation. In December, the Federal Deposit Insurance Corporation approved a proposal outlining how regulated U.S. banks can apply to issue stablecoins through subsidiaries.

Under the framework, banks must submit formal applications, meet reserve and compliance standards, and undergo ongoing regulatory oversight. The FDIC emphasized that only approved institutions will be allowed to issue payment stablecoins under the GENIUS Act.

Still, community banks are urging Congress to clarify the law now, before stablecoin adoption accelerates further and deposit dynamics shift in ways that could be difficult to reverse.