If you build a CBDC right, financial stability – not bank runs — will come, analysis asserts

Done right, a well-designed central bank digital currency (CBDC) may enhance – not weaken – financial stability, according to a blog posting Monday by the Treasury’s financial analysis arm.

A key part of that, according to the posting by the Treasury’s Office of Financial Research (OFR): the risk of bank runs resulting from a CBDC “is not as big as initially feared.”

The blog post is based on a paper (“Central Bank Digital Currency: Stability and Information”), also published by OFR on Monday, that studies the effects of introducing a CBDC “into a model of financial crises” which identifies two countervailing effects: impact on financial stability and bank runs.

The post argues that banks would lower their maturity mismatches when depositors have access to a CBDC, reducing bank exposure to depositor runs. “We use our model to show how having access to a CBDC would decrease depositors’ demand for liquidity services from banks,” the blog post asserts. “Banks respond to this lower demand by reducing the maturity mismatch on their balance sheets, which makes them less exposed to a run. In this way, the adjustments on bank balance sheets, in response to a CBDC, can have a stabilizing influence on the financial system.”

The blog post also asserts that flow of funds into a CBDC would offer a source of “real-time” information to policymakers about the financial system’s state and about depositors’ confidence in their banks. That information could also indicate, the blog post states, when to place troubled banks into resolution sooner.

“For example, in periods of financial stress, depositors and other creditors may withdraw their funding either to meet their own liquidity needs or as part of a run driven by concerns about a bank’s solvency,” the blog post notes. “Monitoring the flows into CBDC would allow policymakers to infer more quickly when a run is underway and to place troubled banks into resolution sooner. Depositors anticipate this faster policy reaction, which decreases their incentive to join the run. In other words, by allowing a quicker policy reaction to a crisis, this information effect is another channel through which a CBDC may improve financial stability.”

But any benefits, the post cautions, will depend on the design of the CBDC. “Decisions about how CBDC balances are held and transferred, as well as any fees or interest payments on balances, will determine how attractive the CBDC is to users in normal times and in periods of stress.”

The posting contends that design choices that make a CBDC attractive in normal times will lead “to the largest decrease in banks’ maturity mismatch.” However, it warns, heavy use of the CBDC in normal times makes it more difficult for policymakers to identify “incipient runs” or other problems quickly.

“A CBDC that is used less in normal times would have a smaller impact on banks’ maturity mismatch but would provide more precise signals in periods of financial stress,” the blog post claims. “Policymakers must balance these competing concerns to design a CBDC that enhances rather than weakens financial stability.”

How would a Central Bank Digital Currency Affect Financial Stability?