The introduction of a central bank digital currency (CBDC) could increase the stability of a banking system, according to a document released Tuesday by the Office of Financial Research of the United States Treasury.
This finding thwarts concerns that a CBDC could encourage runs on weaker banks.
According to the Tuesday article, researchers often claim that the public can, in times of financial stress, “withdraw funds from banks and other financial institutions,” meaning that a “CBDC could make runs on financial firms more probable or more serious”.
The authors, however, argued that a well-designed CBDC could mitigate this risk and also Free two arguments for the role of CBDCs in increasing financial stability.
First, the authors created a mathematical model in which banks performed a maturity transformation. In other words, they borrowed money for periods shorter than those for which they made loans to insure against liquidity risk. This could create financial fragility in the event of an adverse event, and it could lead to a bank run.
In the authors’ model, however, access to a CBDC “intuitively” makes the “experience of a liquidity shock” less costly for depositors, so banks can provide less insurance against this risk. Thus, a CBDC leads to greater stability of the financial system:
“In this way, adjustments to private financial arrangements in response to a CBDC may tend to stabilize rather than destabilize the financial system.”
The second argument was based on a so-called information effect. Banks in a weak position may try to hide this fact from regulators to avoid intervention. Hiding unfavorable information could also aggravate the crisis due to late response.
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However, the nature of CBDCs will allow policymakers to identify situations in which funds are being converted and not simply withdrawn from a bank – thus spotting problems earlier, which can lead to faster resolution:
“By enabling a more rapid political reaction to a crisis, this information effect is another channel through which the CBDC may tend to enhance rather than worsen financial stability.”
The authors point out that other researchers have suggested imposing caps, fees, or other restrictions on the CBDC during crises. The authors argue against this approach, noting:
“Policies that limit the use or attractiveness of the CBDC also risk losing many of its potential benefits.”
They also argue that the benefits of greater information available to decision makers in the presence of a CBDC can have a variety of beneficial uses.