Banks in the Era of Central Bank Digital Currencies
As we enter the era of central bank digital currencies (CBDCs), the big question is what impact will this have on commercial banks.
It depends.
It depends on how central banks set up their digital currencies. The following chart from the BIS highlights the choices central banks face:
The banks are going to fight for Indirect CBDC as it keeps the payment system as the banks’ hostage. If the banks win, we will continue to face the issue of Too Big to Fail as their failure would also bring down the payment system.
We have to hope the central banks choose Hybrid CBDC. Not only does this end the banks holding the payment system hostage, but it also puts in place a structure to maintain privacy.
Regardless of how the CBDC is set up, it will have an impact on banks.
First, it will cause the banks to lose deposits (primarily in the transaction accounts like checking).
Second, it will increase the cost of the deposits that remain with the banks.
Why?
There is no reason for the government to continue to offer a deposit guarantee. Banks are going to have to increase what they pay on deposits to entice investors to keep their money in deposit accounts rather than in the investors’ CBDC accounts.
Please note the introduction of CBDC fundamentally changes how we talk about the owners of bank deposit accounts. They are now investors. And, as every investor knows, they are responsible for all losses on their investments including their uninsured deposits at commercial banks.
Third, it will see banks change their risk profile. Specifically, they will dramatically reduce the amount of risk they take.
Why?
Deposit insurance will no longer subsidize bank risk taking. Rather the bank’s cost of funding will be directly related to the risks it is taking. Banks that are seen as taking on more risk will have to pay more for all of their deposits.
Please note, I do not see the introduction of CBDC as spelling the end for commercial banks. Properly done, the introduction ends the era of banks being masters of the real economy and begins a new era of banks being servants to the real economy.