Federal reserve investigated the implications of an account-based central bank digital currency (CBDC), focusing on its potential competition with the traditional role of commercial banks. Results are very interesting.
“The introduction of digital currencies may justify a fundamental shift in the architecture of a financial system, a central bank ‘open to all,’” the paper, which was published on June 1, reads.
Questions posed by the research arm of the Fed, which were undertaken in collaboration with the Universities of Pennsylvania and Chicago, examined the ramifications of the introduction of a CBDC and how the opening of central bank facilities might affect financial intermediation.
The role of CBDC
Specifically, the questions were aimed at exploring the role CBDCs play in “giving consumers the possibility of holding a bank account with the central bank directly,” in essence replacing the role currently performed by commercial banks.
Maturity transformation refers to the practice by financial institutions of borrowing money on shorter timeframes than they lend out. This is often done through deposits from savers by converting that finance into long-term borrowings such as mortgages. It is the role of commercial banks to facilitate the needs of lenders and borrowers.
CBDC and disruption of commercial banks
This process can backfire though, such as if there is a panic or bank run where all savers attempt to withdraw money at once or if the money markets suddenly dry up due to lenders no longer providing short-term loans to one another.
The paper determined the set of allocations achieved with private financial intermediation (commercial banks) could also be achieved with a CBDC, provided competition is allowed with those commercial banks and depositors do not panic. However, the paper also determined an associated cost involved.
If CBDCs did disrupt the role of commercial banks and allowed the borrowing of more money than is lent out, there’s a concern central banks could harm the money markets.
Rigidity of central banks
The paper also showed how the “rigidity of the central bank’s contract with investment banks” deterred panic runs and, as such, if depositors started to exclusively deposit with the central bank it could end up becoming a “deposit monopolist,” attracting deposits away from the commercial banking sector.
“This monopoly power eliminates the forces that induce the central bank from delivering the socially optimal amount of maturity transformation,” the Fed paper says.