Central Bank Digital Currency, Credit Supply, and Financial Stability

Abstract

We examine the implications of central bank digital currency (CBDC) for credit supply and financial stability using a monetary general equilibrium model. The introduction of deposits in CBDC account decreases credit supply by banks, raising the nominal interest rate and lowering a bank's reservedeposit ratio. This increases the likelihood of bank panic in which banks exhaust cash reserves. However, once the central bank can lend all the deposits in CBDC account to banks, an increase in the quantity of CBDC which does not require reserve holdings can enhance financial stability by increasing credit supply and lowering nominal interest rate.

Central bank digital currency and bank earnings management using loan loss provisions

“…They show that the CBDC will reduce the cost of money circulation and become a strong substitute for demand deposits, but it can increase the risk of bank failure if banks do not respond by increasing the interest rate on term deposits. Kim and Kwon (2022) examine the implications of central bank digital currency for bank credit supply using a monetary general equilibrium model. They show that the introduction of deposits in CBDC account decreases bank credit supply, increases the nominal interest rate, decreases a bank's reserve-deposit ratio and increases the likelihood of bank panic when banks exhaust cash reserves.…”

“…Kim and Kwon (2022) examine the implications of CBDC for bank credit supply using a monetary general equilibrium model. They show that the introduction of deposits in CBDC account decreases bank credit supply, increases the nominal interest rate, decreases a bank’s reserve–deposit ratio and can increase the likelihood of bank panic when banks exhaust cash reserves.…”

“…Bank disintermediation, coupled with low bank-to-CBDC deposit migration cost and ease of deposit migration, can adversely affect bank lending (Auer et al , 2022). A widely held view is that bank disintermediation will increase CBDC deposit with the central bank, reduce the size of deposit with banks, decrease banks’ ability to lend from available bank deposits, decrease the supply of private credit by commercial banks and lead to increase in the nominal interest rate which is undesirable (Kim and Kwon, 2022; Ozili, 2022b; de Lis and Gouveia, 2018). During a crisis, bank lending will decrease due to large migration of bank deposit to CBDC deposit, and bank funding will also decrease (Kumhof and Noone, 2018).…”

“…When the cost of moving deposits from banks to the Central Bank is low or negligible, depositors will have incentives to increase the frequency of bank disintermediation. The decrease in bank deposits will also compel bank managers to take a cautious approach when lending to the private sector (Kim and Kwon, 2022). The precaution in lending would lead to a reduction in lending and a reduction in bank net interest margin and reported earnings.…”

The economics of central bank digital currency

“…42 Similarly, by representing a safe and valuable investment opportunity, the introduction of CBDC may induce investors to substitute bank deposits with CBDC accounts. This reduction in bank deposits can also have negative implications for financial stability: as the supply of private credit is reduced, the nominal interest rate rises and banking panics can occur for a larger set of parameters (Kim and Kwon, 2022).…”