Central bank digital currencies could drive 'fundamental shift' in banking sector: Philadelphia Fed paper
June 6, 2020, 12:23PM EDT
2 min read
The Federal Reserve Bank of Philadelphia's research department has published a new working paper focused on central bank digital currencies, exploring the transformative implications for the make-up of the banking sector.
As noted in the abstract of the paper – entitled "Central Bank Digital Currency: Central Banking for All?" – a central bank's digital currency could make such an institution more attractive to depositors due to the perceived stability. The idea of a CBDC introducing a degree of competition in the banking system has been raised in the past, including in a December note by the IMF.
The Philadelphia Fed paper's authors remark that a CBDC "allows the central bank to engage in large-scale intermediation by competing with private financial intermediaries for deposits," going on to note:
"Yet, since a central bank is not an investment expert, it cannot invest in long-term projects itself, but relies on investment banks to do so. We derive an equivalence result that shows that absent a banking panic, the set of allocations achieved with private financial intermediation will also be achieved with a CBDC. During a panic, however, we show that the rigidity of the central bank’s contract with the investment banks has the capacity to deter runs."
This perception of stability could then take hold among depositors, and the central bank thus "arises as a deposit monopolist, attracting all deposits away from the commercial banking sector," thus posing a threat to maturity transformation. Maturity transformation is a practice among banks by which they secure short-term sources of financing — including deposits — which are then transformed into offerings like mortgages and other long-term forms of lending.
Because central bank digital currencies do not exist — though some are in advanced stages of testing and could go live before the end of 2020 – how such a dynamic would play out in the real world remains to be seen. But the paper is notable as it seeks to explore how something as significant as a CBDC would affect the wider banking world.
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