Blockchain for Banking News

CBDCs could lead to bank disintermediation but less than expected, says ECB report

digital euro currency cbdc

According to a recent working paper by the European Central Bank (ECB), introducing a central bank digital currency (CBDC) as a store of value could increase the risk of bank disintermediation since customers might be driven to switch their deposits for digital currency. But the impact is less than might be thought. The appropriate calibration of certain design CBDC features will mitigate some of these effects.

In Europe, a large proportion of cash is held as a store of value, in contrast to the digital euro’s intention to function primarily as a payment tool. Historically, uncertainty about bank stability has largely driven the demand for public money as a safe liquid asset. However, evidence shows that only a fraction of consumers hold money outside bank accounts for these purposes. Most people keep their savings as bank deposits and use cash as a means of payment.

But even if a digital euro is introduced for transaction purposes, it might also attract people as a potential store of value. For example, individuals could switch their cash holdings for a safe digital asset or replace their bank deposits with CBDCs. These scenarios could have negative implications for the proportion of the population that hold public money as a store of value, as well as for banking sector stability.

Indeed, the authors find that introducing a CBDC would displace some cash holdings as well as some bank deposits. Pessimistic consumers who see the probability of a potential bank run as high would continue holding cash as a safe liquid asset. But if enough people perceived the CBDC as a superior store of value tool, they could retreat toward the digital currency en masse and severely affect the banks’ disintermediation role.

The report says that the balance lies in appropriately calibrating specific digital euro design features, such as remuneration and quantity limits. Namely, if a non-interest-bearing CBDC was issued, its attractiveness might be moderated. The CBDC would still partially replace deposits, but these decline less than proportionally because remaining depositors would be more confident regarding bank stability allowing the banks to rebalance their portfolio towards long-term lending.

However, this last point might be somewhat optimistic. The authors claim that banks will rebalance portfolios towards long-term lending has an important caveat that the report does not highlight.

The problem is that this would translate into increased maturity transformation, the gap in duration between short-term deposits that fund long-term loans. This relative increase in maturity transformation could alleviate the pressure on profitability from the loss of customer deposits. However, banks’ portfolio choices can also have significant feedback effects on the probability of a bank run. By definition, banks take longer to get their money back from long term loans, which is a major cause of instability. Hence, if maturity transformation increased substantially, so would the vulnerability to potential runs.

This is perhaps why another recent paper by the U.S. Treasury’s Office of Financial Research had a more pessimistic view on the impact of digital currencies CBDC on financial stability.

Image Copyright: szemvik / 123rf