Fed Paper: Central Bank Digital Currency could replace commercial banks, but at a cost

Central bank digital currency could one day replace commercial banks. But this carries risks, according to new research by the Federal Reserve of Philadelphia.

Fed research in collaboration with two universities

The 32-page research paper - entitled "Central bank digital currency: central bank for all?" - studied the implications of a Central bank digital currency (CBDC), focusing on its potential competition with the traditional role of transforming commercial bank maturities.

Questions from the Fed's research team, in collaboration with the universities of Pennsylvania and Chicago, examined the implications of introducing a CBDC and how opening a central bank's structures could affect financial intermediation. .

In particular, the questions were intended to explore the role played by CBDCs in "giving consumers the ability to directly hold a bank account with the central bank", essentially replacing the role currently played by commercial banks.

Maturity transformation refers to the practice of financial institutions to borrow money faster than they lend. This is often done through savers' deposits by converting such loans into long-term loans such as mortgages.

It is the role of commercial banks to facilitate the needs of lenders and borrowers. However, this process could backfire, as in the case of a crisis or a bank run in which all Investors attempted to withdraw funds simultaneously or if money markets suddenly ran out due to lenders that no longer made short-term loans.

The decisive role of competition between the two banks

The document established that the set of appropriations reached with private financial intermediation (commercial banks) could also be adequate with CBDCs, provided that competition with these commercial banks and depositors remains under control.

However, the document also quantified an associated cost. "If competition from commercial banks is compromised (for example, through some fiscal subsidy from central bank deposits), the central bank must be careful in its choices to avoid creating chaos by transforming maturities," according to the document. .

In other words, if CBDCs disrupt the role of commercial banks and allow more money to be loaned than is being lent, there is concern that central banks could harm money markets.

The document also showed how the "rigidity of the central bank contract with investment banks" discouraged panic, so if depositors started to turn exclusively to the central bank, it could end up becoming a "deposit monopoly", attracting deposits from the commercial banking sector. "This monopolistic power eliminates the forces that induce the central bank to provide the socially optimal amount of maturity transformation," says the Fed document.