This paper presents a theoretical analysis of how innovation in the form of public payment infrastructures, accessible to all banks with equal efficacy, affects competition in the banking sector. We develop a model of two-bank competition in which one bank’s deposit offers greater payment convenience than its rival’s. In equilibrium, the bank with the convenience advantage captures a larger share of both the deposit market and—via a novel channel involving interest on central bank reserves—the lending market. We show that innovations enabling a uniform level of payment convenience for all consumers help level the playing field between large and small banks. In contrast, paying interest on balances of alternative media of exchange tends

to reinforce the advantages of larger banks. Our theoretical findings are supported by recent empirical evidence from payment innovations in Brazil, China, and the United States.