Adopting CBDC could destabilize banks, help households, US Treasury study says

When integrated into the economy, a CBDC or stablecoin would compete with bank deposits to the public benefit, at least until a financial crisis.

Fully integrating a stablecoin or central bank digital currency (CBDC) into the economy would destabilize banks but improve household welfare, a study released by a United States Treasury division has claimed. The harm to banking caused by the digital currencies could be “significant” in times of stress, it found.

The Office of Financial Research study considered a theoretical “stable state” in the financial sector, after stablecoin or CBDC had been successfully introduced. This contrasts with studies that looked at the risks of bank runs and disintermediation caused by the introduction of the digital currencies.

The authors of the present study saw a risk of systemic deleveraging, that is, a reduction in banks’ equity, leading to reduced stability in times of crisis after the introduction of a digital currency.

Fully integrating a digital currency may improve household welfare, but banking sector stability could suffer.

The @ofrgov explains why in a new blog post here https://t.co/xMzbjadrZR.
For a deeper dive, click https://t.co/4fIpSOCYfm

— Office of Financial Research (OFR) (@OFRgov) March 22, 2023

With a stablecoin or CBDC in place in the economy, they argued, bank deposits would “compete” with the digital currency within households’ liquidity portfolios. That would cause banks to reduce the spread between lending and deposit rates by raising interest paid on deposits, leaving them with less equity than they would have without digital currencies present.

Households would benefit from the competition between banks and digital currency. The authors wrote:

“In our benchmark calibration, in which we calibrate the elasticity between digital currency and deposits to the estimated elasticity between deposits and cash, we find plausible welfare gains on the order of 2% in terms of consumption-equivalent.”

If digital currency competed too well with bank deposits, the resulting financial instability could have a negative effect on households, according to the study. Furthermore, even when that is not the case, the digital currencies may not be the best way increase public welfare. “Profit-maximizing issuers in a competitive market” might outperform digital currency. The authors concluded:

“Our results suggest that financial frictions may limit the potential benefits of digital currencies, and the optimal level of digital currency may be below what would be issued in a competitive environment.”

The study used dense and advanced mathematics and economic theory to advance its arguments. It appeared on March 22, the same day as the White House released Economic Report of the President. The presidential report also expressed concern over the potentially harmful effects of an economically integrated CBDC on the banking system.