Central Banks Could Monopolize Commercial Banking Sector via CBDC, Says Federal Reserve

A new working paper from the Federal Reserve Bank of Philadelphia indicates that the development of a central bank digital currency (CBDC) may create a fundamental shift in the way banks operate.

The Federal Reserve Bank of Philadelphia’s research department recently released a whitepaper entitled, “Central Bank Digital Currency: Central Banking for All?” which explores how CBDCs might directly transform the banking sector.

According to the paper, CBDC could make banking institutions more competitive with emerging financial technology (fintech) firms and investment banks. The Philadelphia Fed’s report supports the findings of CBDC research by the International Monetary Fund (IMF) released in December 2019.

CBDC Could See Central Banks Poach Commerical Banking Customers

According to the paper, “The introduction of a central bank digital currency (CBDC) allows the central bank to engage in large-scale intermediation by competing with private financial intermediaries for deposits. Yet, since a central bank is not an investment expert, it cannot invest in long-term projects itself but relies on investment banks to do so. We derive an equivalence result that shows that absent a banking panic, the set of allocations achieved with private financial intermediation will also be achieved with a CBDC.”

In other words, a CBDC amounts to giving consumers the possibility of holding a bank account with the central bank directly. The researchers also note that the lack of flexibility within a central bank’s contract with investment banks will also deter bank runs in the event of a financial panic.

The authors of the Fed’s research claim that a central bank's digital currency could make such an institution be perceived as more stable and this perception of stability could then take hold among depositors. Ultimately this could lead to a monopoly for the central bank in terms of deposits and poses a threat to the “maturity transformation” of the commercial banking sector. In simple terms, CBDCs could allow central banks to secure more short-term sources of finance and deposits and begin offering services like mortgage lending and other types of loans usually facilitated by commercial and investment banks.

Dawn of the CBDC

The catalyst for central banks to develop CBDCs came from the rise and potential of a digital and financial global transformation that could occur through private initiatives such as Bitcoin, Ethereum, and Libra. Since the emergence and increasing traction of these decentralized projects: researchers and policymakers have explored the possibility that central banks can also issue their own digital currencies.

Currently, no central bank has managed to roll out its central bank digital currency, although many are in the advanced stages of their testing with China hinting they will go live this year.

While researchers continue to hypothesis the precise impact a CBDC could have on the global financial sector and the wider world of banking, reports of how they will be developed are conflicting and the effects will not be truly realized until the CBDCs are rolled out.