cbdc stability

Introduction and general overview In October 2020, this group set out three common foundational principles for considering issuing a central bank digital currency (CBDC) that flow from their common objectives (Group of central banks (2020)). The first of these principles was ”do no harm” – this does not mean ”have no impact”, but rather that new forms of money supplied by the central bank should continue supporting the fulfilment of public policy objectives and should not impede and ideally enhance, a central bank’s ability to carry out its mandate for monetary and financial stability. This principle arose from a recognition that while a CBDC has the potential to provide benefits to the operation and resilience of the financial system (particularly regarding payment services), a CBDC could also affect existing financial market structures and business models, which may pose risks to financial stability as the financial system evolves, particularly via the potential disintermediation of banks. Many jurisdictions are still in the early stages of investigating the case for introducing a CBDC, with key design choices and implementation models still under consideration. For the purposes of this work, we focus on forms of CBDC that are intended primarily for retail use, and that would co-exist with private payment systems. We make an implicit assumption that CBDCs would most likely be offered with tools to minimise criminal usage and money laundering risks ie less anonymous than cash, operating via intermediaries.1 Many jurisdictions are also actively considering how any CBDC framework might also incorporate safeguards that could reduce uncertainty during any transition, and could also be considered on a permanent basis, eg to have CBDC function primarily as a means of payment rather than as a store of value. The intention of this report is to consider how, and under what conditions, material risks to financial stability and the ability of authorities to maintain financial stability could arise. The report focuses on the impact on the intermediation capacity and resilience of the banking system, where risks are considered primarily relative to current bank business models and balance sheets. Implications for some aspects of market financing are also discussed. As a result, this initial assessment is bounded by three significant uncertainties: (i) the future structure of the financial system; (ii) the design of a CBDC and its underlying system; and (iii) the size and scale of user adoption. While this report focuses primarily on potential risks and mitigants, decision-makers will, in practice, need to consider these risks against potential benefits and counterfactuals. For example, similar effects and risks could arise, potentially in a less controllable way, with certain new forms of private sector money. If issued, a CBDC would likely co-exist with private forms of money in a future financial system that could look very different from that which we observe today. Stablecoins are only just starting to be developed and will need to satisfy regulators that they are safe, but subject to that, data-driven business models and strong network effects could mean there is significant use in the future (G7 (2019)).2 Unlike central banks, issuers of stablecoins are not bound by principles to design products that would co-exist and interoperate with other forms of money or to promote ongoing innovation and efficiency (ie the second and third principles outlined in Group of central banks (2020)). This could cause fragmentation in a payments ecosystem, just like any other closed-loop payment system (CPMI (2018)). Significant stablecoin adoption and the potential consequent fragmentation could result in excessive market power and the type of deposit disintermediation described as a risk for CBDC issuance, but with lower public benefits. As a result, the central banks contributing to this report have already identified that a CBDC could 1 This includes the possibility that a CBDC could be fully anonymous for small value payments but not for large payments. 2 Stablecoins vary greatly in risk profile depending on their structure and backing. Hereafter, this report uses the term “stablecoin” to refer to stablecoins that are fully backed by low-risk assets and are well-regulated, so may be perceived as a money substitute. 2 Central bank digital currencies: financial stability implications be an important instrument for ensuring that they can continue delivering their public policy objectives even as the financial system evolves The report briefly outlines the factors that could affect the take-up of CBDC (also explored in Group of Central Banks (2021b)). Given the considerable uncertainty regarding CBDC demand, a range of take-up scenarios are explored. The report then explores the implications for commercial banks in benign conditions, for non-bank funding, and for the speed and scale of possible bank runs from uninsured deposits. The latter part of the report then analyses options for safeguards and mitigants, although it does not discuss in detail the possible intervention of central banks to use policy tools to offset any transitory impacts on lending. This report cannot be conclusive and is not a statement of policy. Instead, it adds to previous analysis on this topic by pooling the expertise of central banks who are all actively engaged in similar analysis at a domestic level. By exploring these important dynamics, this report provides a framework for further work as the current financial system evolves and CBDC design options are explored and refined. Key messages: • To help maintain safety and stability, a CBDC would need careful design and implementation, allowing time for the existing financial system to adjust and flexibility to use safeguards. • CBDCs would have implications for financial intermediation and would need careful design and implementation; but our analysis suggests the impacts on bank disintermediation and lending could be manageable for the banking sector. A significant shift from bank deposits into CBDCs (or even into certain new forms of privately issued digital money) could have implications for lending and intermediation by the banking sector. However, our analysis also suggests that these impacts would likely be limited for many plausible levels of CBDC take-up, if the system had the time and flexibility to adjust. This initial assessment is subject to uncertainties over the future structure of the financial system, the design of a CBDC and its underlying system, the size and scale of user adoption of CBDC and differences between jurisdictions. • We note that the financial system is dynamic and evolving and has successfully navigated episodes of structural change over many years. Additionally, private sector developments may generate similar deposit substitution risks, irrespective of CBDC and the introduction of CBDC may generate additional innovative opportunities for banks and other financial intermediaries. Central banks would have to carefully consider how they would manage these impacts, particularly through any transition phase for CBDC. • However additional risks to financial stability might arise if changes in the structure of the financial system due to the adoption of a CBDC were to be abrupt. Impacts would also depend on the extent of the offsetting increase in lending to the real economy by non-bank financial intermediaries. CBDC and certain new forms of digital money could also increase the latent risk of systemic bank runs. This risk is reduced in the existing system through effective banking regulation, deposit insurance, and resolution frameworks • Central banks are exploring safeguards that could be built into any CBDC to address financial stability risks; although such measures may need careful consideration before they were used. Central banks might consider measures to influence or control CBDC adoption or use. This could include measures such as access criteria for permitted users, limits on individuals’ CBDC holdings or transactions, and particular choices around CBDC remuneration. Such measures could be valuable in managing risks in any transition were a CBDC to be introduced and could potentially have a role on a longer-term basis in some jurisdictions. However, such measures would also bring challenges. The design of any measures would likely need to balance moderating the risks from high and/or rapid take up of CBDC with other policy objectives associated with a meaningful level of usage. In some cases, there could be legal and public policy issues to consider. For Central bank digital currencies: financial stability implications 3 example, there might be some measures that may face obstacles to public understanding and acceptance. • Further work is needed to fully understand the entire range of effects and quantify the possible implications for financial stability from CBDCs, particularly to understand potential take-up for different CBDC designs, the optimal design of any safeguards, how non-banks and third-party providers might be affected, and the opportunities to enhance financial stability as the payments landscape continues to evolve. Observations from early CBDC launches and pilot schemes could be very useful in this regard. Conclusions This report has focused primarily on potential risks to financial stability that could arise from the introduction of a CBDC and how to mitigate these risks. These risks need to be considered alongside the benefits and counterfactuals. A CBDC has the potential to offer new opportunities for innovation, which may benefit banks, and non-bank/third-party providers of financial services, supporting a competitive and diverse financial system. This could facilitate new opportunities for innovation and increase the resilience of the system overall – subject to authorities ensuring appropriate regulation of all parties. At the same time there is also continuing change in payment methods and emergence of new forms of privately issued digital money, some of which pose risks themselves. The introduction of a CBDC could prompt some changes that affect the functioning of the financial system in ways similar to the introduction of new forms of private money such as stablecoins. The extent and nature of these changes would depend on take-up, which remains highly uncertain and depends on design features and attractiveness relative to deposits. The choice of a remuneration approach, and competitiveness with bank deposits, would likely be a key factor determining take-up, but non-pecuniary factors ranging from privacy to payments access could be important as well. Potential benchmarks for take-up would include factors that are specific to each jurisdiction, such as the payment attitudes and volume of currency in circulation. A material shift from bank deposits to CBDC – which would be possible for example if the holdings of CBDCs by individual users were left unconstrained – could have a non-trivial, long-term impact on bank lending and intermediation, although these impacts may be limited for many plausible levels of CBDC take-up and if the system has time to adjust. Estimates from a simple, partial model suggest that a large shift from bank deposits to CBDC could plausibly lead to a fall in bank profitability in benign circumstances, assuming normalized monetary conditions. This could in turn affect lending conditions and/or the resilience of banks. It could imply more reliance by banks on wholesale market funding. Greater take-up levels would have a greater impact on the financial system. Moreover, the impact could be exacerbated if the response of the banking system strains the capacity of funding markets. This is more likely to occur if deposits were lost over a shorter time frame. The implications could also be larger for some types of bank business model than others. In the context of negative interest rates, decisions around whether and how to remunerate a CBDC become more complex, given the presence of unremunerated cash, and potential 18 Central bank digital currencies: financial stability implications competition with bank deposits or money instruments with negative interest rates. Given the prevalence of negative interest rates and current proximity to the zero-lower bound in many jurisdictions, issues related to negative interest rates require further consideration. Yet additionally, the existence of unconstrained CBDCs, or other digital money, as an easily accessible, safe asset could increase the risk of systemic banks runs and make money market funds or instruments more susceptible to abrupt outflows. A similar effect could arise for other sectors seen as relatively safe, notably in money markets. That said, the presence of a CBDC could, over time, increase diversity of providers of payments and other financial intermediation services. The introduction of a CBDC could make it easier for new financial service providers to enter the market for payments services or to improve the competition amongst banks and non-banks for lending – increasing the diversity of financial service provision. This in turn, subject to appropriate regulation of all participants, could increase the resilience of financial service provision to shocks and reduce the impact of financial crises overall. Central banks can introduce safeguards in a CBDC framework to reduce financial stability risks, notably by limiting take-up permanently or on a transitional basis. Financial stability risks also need to be carefully considered for private digital money and are potentially more challenging to manage than for CBDC. Depending on the specific rationale in a jurisdiction for pursuing CBDC, combinations of limits on CBDC holdings or transactions, or remuneration disincentives, could be deployed to moderate take-up. Calibration of limits or remuneration frameworks would need to balance moderating the take-up of CBDC, specifically substitution with private money and deposits, with allowing a CBDC to fulfil its public policy objectives. Technical solutions that allow for monitoring and implementation of limits would also need to be considered in the design phases of a CBDC, and some safeguards may be easier to implement than others. A CBDC (or certain new forms of privately issued digital money) could also change run dynamics in a stress, and the latent level of liquidity risk banks face. Authorities might need to consider adjusting prudential liquidity requirements or other measures such as the terms of their crisis lending facilities. The potential for more abrupt flows out of money market instruments may also demand further consideration of prudential regulation in that sector. And to the extent that CBDCs encourage new entrants and the growth of non-bank financial services, authorities would need to ensure appropriate regulation of these entities. Overall, considerable further work is needed to fully understand the full range of effects and quantify the implications for financial stability from CBDCs (including the risks and also the opportunities to enhance financial stability as the payments landscape continues to evolve), and the various design, remuneration and safeguard options. The novelty of a CBDC creates many difficult to answer questions around firstly, the extent of potential take-up, and secondly how banks, nonbanks and other providers might react to its introduction. Initial, illustrative analysis has helped shed some light on partial responses to changes in bank funding, but they have also revealed that more consideration is needed of when behavioural responses could lead to bigger impacts, and when offsetting affects might appear. Furthermore, much attention to date has been focused on risks to banks, and more consideration of the impact on money markets may be worthwhile. Observations from early CBDC launches and pilot schemes could be useful in providing more information.