The implementation of a central bank digital currency (CBDC) can increase the stability of a banking system, according to a document released Tuesday by the US Treasury’s Bureau of Financial Investigation.
This finding counters concerns that a CBDC could encourage runs on weaker banks.
According to the July 12 document, researchers often state 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 companies more likely or more serious.”
However, the authors argue that a well-designed CBDC can mitigate that risk, and they also offer two arguments that favor the role of CBDCs in increasing financial stability.
First, the authors created a mathematical model in which banks performed a maturity transformation, that is, they borrowed money for shorter periods than they granted, to insure against liquidity risk. This could create financial fragility in the event of an adverse event that could eventually lead to a bank run.
In the authors’ model, however, access to a CBDC makes “intuitively” that “experiencing a liquidity shock” is less costly for depositors, so banks can provide less insurance against this risk. Therefore, a CBDC leads to greater stability of the financial system.
“In this way, adjustments in private financial arrangements in response to a CBDC may tend to stabilize rather than destabilize the financial system.”
The second argument is based on the so-called information effect. Weak banks may try to hide that fact from regulators to avoid intervention. Hiding unfavorable information could also aggravate the crisis due to a delayed response.
However, the nature of CBDCs will allow policymakers to identify situations where funds are being converted, and not simply being withdrawn from a bank, thereby spotting problems earlier, which can lead to faster resolution. .
“By enabling faster political reaction to a crisis, this information effect is another channel through which a CBDC may tend to enhance rather than worsen financial stability.”
The authors note that other researchers have suggested imposing caps, fees, or other restrictions on CBDCs during crises. The authors oppose this approach, noting that:
“Policies that limit the use or attractiveness of a CBDC risk losing many of its potential benefits as well.”
They also argue that the benefits of the increased information available to policymakers in the presence of a CBDC can have a variety of beneficial uses.
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