The introduction of a central bank digital currency (CBDC) could increase the stability of a banking system, according to a document released Tuesday by the United States Treasury Office of Financial Research.
This finding refutes concerns that a CBDC could encourage runs on weaker banks.
According to the July 12 paper, researchers often argue that during times of financial stress, the public can “take money out of banks and other financial institutions,” meaning that a “CBDC could make the risk on financial firms more likely or severe.”
However, the authors argued that a well-designed CBDC can mitigate that risk, and also put forward two arguments favoring the role of CBDCs in increasing financial stability.
First, the authors created a mathematical model in which banks performed maturity transformation, that is, they borrowed money for shorter periods than for which they lent, to insure themselves against liquidity risk. This can lead to financial fragility in the event of an adverse event, leading to a bank run.
However, in the authors’ model, access to a CBDC ‘intuitively’ makes ‘experiencing a liquidity shock’ less costly for depositors, so that banks are less able to insure against this risk. In this way, a CBDC leads to more stability of the financial system.
“In this way, the adjustments in private financial arrangements in response to a CBDC may tend to stabilize rather than destabilize the financial system.”
The second argument was based on a so-called information effect. Banks in a weak position may try to hide that fact from regulators to avoid intervening. Hiding unfavorable information can also exacerbate the crisis through a delayed response.
However, the nature of CBDCs allows policymakers to identify situations where money is being converted and not simply withdrawn from a bank, helping to spot problems earlier, which can lead to faster resolution.
“By enabling a faster policy response to a crisis, this information effect is another channel through which CBDC improves rather than worsens financial stability.”
The authors point out that other researchers have suggested imposing limits, fees or other restrictions on CBDC during crises. The authors argue against this approach, noting:
“Policies that limit the use or attractiveness of CBDC also risk losing many of its potential benefits.”
They also argue that the benefits of the greater information available to policymakers in the presence of a CBDC could have several beneficial uses.