Tag Archives: Central bank digital currency

Does CBDC Increase Run Risk?

Central bankers often argue that CBDC would increase the risk of bank runs. On his blog, JP Koning rejects this notion. After all, he retorts, during a confidence crisis bank customers would no longer have to queue to withdraw cash; lender of last resort support would be provided much more quickly; and “large” cash holders would continue to shift funds into treasury bills, not into CBDC.

Koning writes:

The general criticism here is that during a crisis, households and businesses will desperately shift their deposits into the ultimate risk-free asset: central bank money. Presumably when deposits were only redeemable in banknotes (as is currently the case) and one had to trudge to an ATM to get them, this afforded people time for sober contemplation, thus rendering runs less damaging. But if small depositors can withdraw money from their accounts while in their pajamas, this makes banks more susceptible to sudden shifts in sentiment, goes the Carney critique.

I don’t buy it. … even in jurisdictions without deposit insurance, I still don’t think that shifts into digital currency in times of stress would exceed shifts into banknotes. A bank will quickly run out of banknotes during a panic as it meets client redemption requests, and will have to make arrangements with the central bank to get more cash. Thanks to the logistics of shipping cash, refilling the ATMs and tellers will take time. In the meantime a highly visible lineup will grow in front of the bank, exacerbating the original panic. Now imagine a world with digital currency. In the event of a panic, customer redemption requests will be instantaneously granted by the bank facing the run. But that same speed also works in favor of the bank, since a request to the central bank for a top-up of digital currency could be filled in just a few seconds. Since all depositors gets what they want when they want, no lineups are created. And so the viral nature of the panic is reduced.

But what about large depositors like corporations and the rich … ? During a crisis, won’t these sophisticated actors be more likely to pull uninsured funds from a bank, which have a small possibility of failure, and put them into risk-free central bank digital currency?

I disagree. In a traditional economy where banknotes circulate, CFOs and the rich don’t generally flee into paper money during a crisis, but into short-term t-bills. Paper money and t-bills are government-issued and thus have the same risk profile, t-bills having the advantage of paying positive interest whereas banknotes are barren. The rush out of deposits into t-bills is a digital one, since it only requires a few clicks of the button to effect. Likewise, in an economy where digital currency circulates, CFOs are unlikely to convert deposits into barren digital currency during stress, but will shift into t-bills. The upshot is that banks are not more susceptible to large deposit shifts thanks to the introduction of digital currency—they always were susceptible to digital bank runs thanks to the presence of short-term government debt.

Of course, depending on the type of CBDC, central banks might also choose to pay negative interest on CBDC in order to depress demand for it.

BIS report on CBDC

A BIS report submitted by the Committee on Payments and Market Infrastructures and the Markets Committee discusses potential implications of the introduction of central bank digital currency for payments, monetary policy, and financial stability.

From the executive summary

… CBDC is potentially a new form of digital central bank money that can be distinguished from reserves or settlement balances held by commercial banks at central banks. There are various design choices for a CBDC, including: access (widely vs restricted); degree of anonymity (ranging from complete to none); operational availability (ranging from current opening hours to 24 hours a day and seven days a week); and interest bearing characteristics (yes or no).

… Two main CBDC variants are … a wholesale and a general purpose one. The wholesale variant would limit access to a predefined group of users, while the general purpose one would be widely accessible.

… Traditionally, central banks have … This approach has, in general, served the public and the financial system well, setting a high bar for changing the current monetary and financial structure.

Wholesale CBDCs, combined with the use of distributed ledger technology, may enhance settlement efficiency for transactions involving securities and derivatives. Currently proposed implementations for wholesale payments – designed to comply with existing central bank system requirements relating to capacity, efficiency and robustness – look broadly similar to, and not clearly superior to, existing infrastructures. …

In part because cash is rapidly disappearing in their jurisdiction, some central banks are analysing a CBDC that could be made widely available to the general public and serve as an alternative safe, robust and convenient payment instrument. … analysing whether these goals could also be achieved by other means is advisable, as CBDCs raise important questions and challenges … the benefits of a widely accessible CBDC may be limited if fast (even instant) and efficient private retail payment products are already in place or in development.

… a central bank introducing such a CBDC would have to ensure the fulfilment of anti-money laundering and counter terrorism financing (AML/CFT) requirements, as well as satisfy the public policy requirements of other supervisory and tax regimes. … in some jurisdictions central banks may lack the legal authority to issue a CBDC … compared with the current situation, a non-anonymous CBDC could allow for digital records and traces, which could improve the application of rules aimed at AML/CFT.

Issuance of a CBDC would probably not alter the basic mechanics of monetary policy implementation, including central banks’ use of open market operations. … However, if flows into CBDC were to become large and not associated with offsetting declines in physical banknotes, as could be the case in times of financial stress, challenges could arise (such as a need to broaden the assets that the central bank can hold or take on as collateral).

CBDC could enrich the options offered by the central bank’s monetary policy toolkit, eg by allowing for a strengthening of pass-through of policy rate changes to other interest rates or addressing the zero lower bound (or the even lower, effective bound) on interest rates. … other more conventional tools and policies can to some extent achieve similar outcomes without introducing new risks and challenges (such as implementing negative interest rates on public holdings of a general purpose CBDC). And some of these gains might not arise without discontinuing higher denomination banknotes …

Implications are more pronounced for monetary policy transmission and financial markets, especially if a CBDC was to be designed as, or de facto became, an attractive asset. … could function as a safe asset comparable in nature to short maturity government bills. A general purpose variant could compete with guaranteed bank deposits, with implications for the pricing and composition of banks’ funding.

… A general purpose CBDC could give rise to higher instability of commercial bank deposit funding. Even if designed primarily with payment purposes in mind, in periods of stress a flight towards the central bank may occur on a fast and large scale, challenging commercial banks and the central bank to manage such situations. Introducing a CBDC could result in a wider presence of central banks in financial systems. This, in turn, could mean a greater role for central banks in allocating economic resources … It could move central banks into uncharted territory and could also lead to greater political interference.

For currencies that are widely used in cross-border transactions, all the considerations outlined above would apply with added force, especially during times of generalised flight to safety. …

… Further research …

Saga—A Global CBDC?

In the FT, Martin Arnold reports about plans to launch “Saga,” a reserves-backed krypto currency, maybe the closest substitute yet to central bank digital currency.

It is being launched by a Swiss foundation with an advisory board featuring Jacob Frenkel, … Myron Scholes, … and Dan Galai, co-creator of the Vix volatility index. The currency aims to avoid the wild price swings of many cryptocurrencies by tethering itself to reserves deposited in a basket of fiat currencies at commercial banks. Holders of Saga will be able to claim their money back by cashing in the cryptocurrency.

Saga also aims to avoid the anonymity of bitcoin that raises financial crime concerns with regulators and bankers. It will require owners to pass anti-money laundering checks and allow national authorities to check the identity of a Saga holder when required.

Deposits will be made in the IMF’s special drawing right basket of currencies, which is heavily weighted in US dollars.

Reserves for All come into sight.

Update (30 March): From the white paper:

Saga … deploys a reserve anchoring algorithm, serving to stabilise the currency in terms of leading state-issued currencies. As Saga gains trust, its reserve ratio will decrease in favour of an independent establishment of value.

???

“Blockchain from a Central Bank Perspective”

An excellent conference organized by the Monetary Law Forum Switzerland focused on blockchain use cases from a central bank perspective. Program, links to slides.

I discussed the macroeconomic perspective and argued for “reserves for all.”

Some related links: Nivaura and Allen & Overy (backing Nivaura). OTC Swiss Blockchain, by Roman Bischoff.