As the world’s digital transformation accelerates, money and payments are coming along for the ride.
Or leading the charge, depending on who you ask.
This, as a new report from The Office of Financial Research (OFR), an independent bureau reporting to the U.S. Department of the Treasury, finds that central bank digital currencies (CBDCs) could significantly increase household welfare while at the same time harm banks, which would find themselves at a disadvantage in this new economy, as well as cause greater financial instability.
In the paper, “Digital Currency and Banking-Sector Stability,” government researchers modeled a financial sector where digital currencies coexist with bank deposits, finding: “Digital currency, whether privately or publicly issued, is likely to be detrimental to financial stability, and bank valuations can be significantly harmed.”
It also found that “times of distress and crisis increase monotonically with the supply of digital currency, and bank valuations decrease substantially.”
In the last decade, payments using cash and checks have declined dramatically while the use of digital payments have notably increased, making the establishment and regulation of digital financial infrastructure a key 21st century priority for nations around the world.
But what is bad news for the traditional banking sector may be good news for the everyday United States consumer.
“Household welfare can increase significantly despite the decrease in financial stability,” the OFR paper found. “These welfare consequences are potentially large but depend critically on the degree of substitutability between deposits and digital currency.”
“This creates misaligned incentives between the banks and the households who own the banks,” added the government researchers. “The financial sector could rationally oppose digital currencies while digital currencies could be welfare-improving.”
If digital currencies were to become an alternative to traditional money, they would “depress deposit spreads, which hinders banks’ abilities to recapitalize following losses.”
The paper’s concluding remarks suggest that “financial frictions” may limit the potential benefits of digital currencies, and the “optimal level of digital currency [for households and banks] may be below what would be issued in a competitive environment.”
The benefits of CBDCs include cheaper, hyper-efficient, real-time settlements and broader financial inclusion.
There are multiple varieties of CBDCs — either a retail CBDC, which can be used by the public for payments, similar to cash; a wholesale CBDC, which can be used by member banks and other FIs to transact with each other and move money in real time; or a hybrid version of the two.
U.S. lawmakers are taking aim at all three varieties, warning of threats to civil liberty and financial freedom, as well as a reduction of the U.S. dollar’s primacy within the global economy.
As reported by PYMNTS, both Florida Gov. Ron DeSantis, a likely GOP presidential candidate, and Texas Sen. Ted Cruz, and former GOP presidential candidate, have this week introduced legislation aimed at blocking CBDC use.
DeSantis’ proposal is meant to explicitly prohibit the use of federal or foreign CBDC as money within the state of Florida.
“[This proposal] will protect Florida consumers and businesses from the reckless adoption of a ‘centralized digital dollar’ which will stifle innovation and promote government-sanctioned surveillance,” DeSantis said Monday (March 20), adding that a federal CBDC, which he called “Big Brother’s Digital Dollar,” would also diminish the role of community banks and credit unions.
Cruz’s bill, cosponsored by Sens. Mike Braun of Indiana and Charles Grassley of Iowa, introduced after the Florida governor’s proposal, takes a slightly different tack and aims to block the Federal Reserve itself from attempting to create a retail CBDC.
“The federal government has no authority to unilaterally establish a central bank currency,” Cruz said Tuesday (March 21). “This bill goes a long way in making sure big government doesn’t attempt to centralize or control cryptocurrency and instead, allows it to thrive in the United States.”
At the center of both proposals is the fact that, as a core function, CBDCs would be fully traceable, meaning that every transaction would be implicitly recorded and monitored by the central bank.
As covered earlier by PYMNTs, a new report authored by the White House Council of Economic Advisers revealed “a demand for a faster and more inclusive financial system with a real-time payment system and circulating digital money.”
“This vision has not been realized,” the report added.
It remains to be seen whether such a system ever will be realized, and if it does, what form it will take.
The White House report, for its part, added that FedNow, which launches this July, “could help bring the U.S. financial infrastructure into the digital era in a clear and simple way.”
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