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US Treasury study finds CBDCs a plus for commercial bank stability

CBDCs have been found to lessen banks' requirement for insurance against liquidity risks and provide regulators with more information about financial system problems

By Shashank Bhardwaj

Published: Jul 13, 2022 05:45:13 PM IST

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A paper released on Tuesday by the US Treasury Office of Financial Research stated that the adoption of Central Banking Digital Currency (CBDC) may help stabilise the banking system. The study dispels concerns that a CBDC may inspire bank runs on weak financial institutions.

The study further stated that researchers frequently assert during times of financial crisis that people may "pull funds out of banks and other financial institutions.” And CBDCs could “make runs on financial firms more likely or more severe."

However, the authors gave two reasons for the importance of CBDCs in boosting financial stability and contended that a well-designed CBDC would lessen that risk.

The authors built a mathematical model where banks were performing maturity transformation. In an effort to protect themselves against liquidity risk, they borrowed money for shorter durations than they offered loans for. In case of a negative event, this could lead to financial fragility, which could trigger a bank run.

However, according to the model, having access to a CBDC reduces the cost of depositors "experiencing a liquidity shock”, allowing banks to offer less protection against such a risk and adding to the financial stability of the banking system.

"In this way, the adjustments in private financial arrangements in response to a CBDC may tend to stabilise rather than destabilise the financial system."

The second defence rested on a concept known as the information effect. In order to prevent intervention, banks in precarious conditions may try to conceal that fact from authorities. Hiding negative facts could further worsen the issue due to a slow response.

Conversely, the design of CBDCs will give decision-makers the capacity to discover instances where money is being converted rather than at the time of withdrawal from a bank, allowing for earlier detection of issues and a quicker resolution.

"By allowing a quicker policy reaction to a crisis, this information effect is another channel through which CBDC may tend to improve rather than worsen financial stability," said the study.

The authors also noted other academics' recommendations to impose CBDC crisis-related caps, fines, or other restrictions: "Policies that limit the use or attractiveness of CBDC risk losing many of its potential benefits as well."

Additionally, they contended that having a CBDC may have a number of advantages for policymakers due to the increased information at their disposal.

The writer is the founder at yMedia. He ventured into crypto in 2013 and is an ETH maximalist. Twitter: @bhardwajshash