Today the Bank of Korea (BOK) published a report following its economic analysis of the impact of Central Bank Digital Currency (CBDC). The report concluded that the effect on financial stability could be negative under certain circumstances, but suggested alternatives.
The threat to financial stability is when the CBDC is an interest-bearing central bank account which competes with commercial banks. As a result, commercial banks have fewer deposits, so they will be able to lend less, which raises the nominal interest rate.
The net effect is there’s too little lending, so in order to try to increase the money supply, the central bank mandated reserve-deposit ratio would be lowered. Given banks have fewer reserves, there’s a higher risk of them running out of cash. This increases the probability of bank runs and negatively impacts financial stability.
However, the BOK report states the alternative is for the central bank to lend all the deposits in the CBDC account to commercial banks. In turn, commercial banks can lend more money to their customers, and the increase in the supply of retail credit reduces the likelihood of bank runs. Hence financial stability is improved.
BOK also highlighted areas for potential future exploration. One topic is to explore what might happen when the entire economy faces a bank-panic risk. Another is to investigate if CBDC accounts could be made via deposits at commercial banks rather than held at the central bank. Finally, the optimal interest rate for a CBDC should be investigated.
Last month the Bank for International Settlements (BIS) published a report on CBDC adoption which stated that 70% of banks are engaged in or about to start work on a CBDC, though the vast majority are just exploratory. Although several banks have published reports on their experiments, the majority have been about the technical implementations. Instead, South Korea focused on economic models.