Forbes India 15th Anniversary Special

US Treasury Division Study Suggests Digital Currency Integration Could Destabilise Banks but Improve Household Welfare

The study argues that profit-maximising issuers in a competitive market might be better suited to outperform digital currencies

Shashank Bhardwaj
Published: Mar 23, 2023 03:34:31 PM IST
Updated: Mar 23, 2023 09:10:02 PM IST

US Treasury Division Study Suggests Digital Currency Integration Could Destabilise Banks but Improve Household WelfareImage: Shutterstock

According to a study conducted by a division of the US Treasury, if a stablecoin or central bank digital currency is fully integrated into the economy, it could lead to a destabilisation of banks, but it could also improve the welfare of households. The study suggests that the damage to the banking sector caused by digital currencies could be significant during times of stress. 

The study focused on the potential impact of stablecoins and CBDCs in a theoretical stable state after their successful introduction, in contrast to previous studies that looked at the risks such as bank runs and disintermediation caused by the introduction of these digital currencies.

The study's authors noted a potential risk of systemic deleveraging if a digital currency were introduced, meaning that banks' equity could decrease, leading to instability during a crisis. They argued that if a stablecoin or CBDC were introduced, it would compete with bank deposits for households' liquidity portfolios. 

This competition could cause banks to reduce the spread between lending and deposit rates, resulting in a higher interest rate paid on deposits and less equity for the banks due to the presence of digital currencies.

The authors stated that households would experience positive effects from the competition between banks and digital currencies. They stated that in their benchmark calibration, where they calibrated the relationship between digital currencies and deposits based on the estimated relationship between deposits and cash, they found reasonable welfare gains of around 2 percent in terms of consumption-equivalent.

The study suggests that if digital currencies were to compete too strongly with bank deposits, it could lead to financial instability and have negative effects on households. 

Additionally, even in situations where this is not the case, digital currencies may not necessarily be the best way to enhance public welfare. The study argues that profit-maximising issuers in a competitive market might be better suited to outperform digital currencies. 

Based on their findings, the authors concluded that financial frictions could limit the potential benefits of digital currencies, and that the optimal level of digital currency might be lower than what would be issued in a competitive environment.

The study relied on complex mathematics and economic theory to support its claims. It was published on March 22, which is the same day that the White House released the Economic Report of the President. The presidential report also expressed concerns about the potential negative impact of an economically integrated CBDC on the banking system.

Shashank is the founder of yMedia. He ventured into crypto in 2013 and is an ETH maximalist. Twitter: @bhardwajshash

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