The introduction of the Central Bank Digital Currency (CBDC) could increase the stability of the banking system, according to a treatise published Tuesday by the Office of Financial Research of the US Treasury.
This finding counters concerns that the CBDC may facilitate implementation in weak banks.
According to a July 12 treatise, researchers often argue that the public may “withdraw money from banks and other financial institutions” during times of financial stress.
However, the authors say that a well-designed CBDC can mitigate that risk, and Offer Two arguments supporting the role of the CBDC in increasing fiscal stability.
First, the authors created a mathematical model in which banks perform maturity conversions, that is, borrow funds in a shorter period of time than banks lend, to guarantee liquidity risk. This can create financial vulnerabilities in the event of an adverse event and can lead to a run on the bank.
However, in the author’s model, banks can have less insurance against this risk because they have “intuitive” access to the CBDC, which lowers the cost of “experiencing a liquidity shock” for depositors. Therefore, the CBDC enhances the stability of the financial system.
“Thus, coordination of private financial agreements for the CBDC may tend to stabilize the financial system rather than destabilize it.”
The second argument was based on the so-called information effect. Vulnerable banks may try to hide that fact from regulators to avoid intervention. Hiding unfavorable information can also exacerbate the crisis due to delayed response.
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However, the nature of the CBDC allows policy makers to identify situations where funds are being converted, rather than simply being withdrawn from banks. Therefore, it may find the problem faster and lead to a faster solution.
“By allowing for a quicker policy response to the crisis, this information effect is another channel in which the CBDC tends to improve rather than worsen fiscal stability.”
The authors point out that other researchers have proposed imposing caps, fees, or other restrictions on the CBDC in the event of a crisis. The author disagrees with this approach and states:
“A policy that limits the use and appeal of the CBDC risks losing many of its potential benefits.”
They also argue that the benefits of more information available to policy makers in the presence of the CBDC may have a variety of useful uses.