Could CBDCs end bank runs forever?
Jan Eeckhout, in commentary, argues that CBDCs can end bank runs forever since as the lender of last resort, the central bank could issue as much money as needed if depositors wanted to withdraw their money simultaneously.
A CBDC would bring market discipline to the banking sector. Traditional banks would be forced to focus on picking profitable loans, and they would close most of their network of retail branches. Likewise, the credit-card oligopoly that hijacks our credit-less payment system would melt like snow in the sun. In its place, we would get a fluid payment system operated by a network of competitors offering access to your CBDC account.
The Simplest Fix for Banking
By: Jan Eeckhout – Universitat Pompeu Fabra
…it might not be so straightforward!
In this paper, Chen and Phelan examine how digital currencies, whether issued publicly or privately, would affect the stability of the traditional financial sector. They introduce digital currency into a continuous-time stochastic general equilibrium model in which financial frictions endogenously create instability and systemic risk. In their model, banks invest in productive capital, but due to frictions, banks’ marginal source of funding is typically risk-free deposits because issuing equity is costly. When digital currencies are added, they function as a substitute form of liquidity that competes with bank deposits. Most importantly, digital currencies decrease the spreads on bank deposits, thus affecting the ability of banks to rebuild equity following losses. The authors’ model predicts:
- A digital currency can significantly harm the stability of the banking sector: times of distress and crisis increase monotonically with the supply of digital currency, and bank valuations decrease substantially.
- In terms of welfare: households’ welfare can increase significantly as long as a digital currency is not a perfect substitute for deposits. In that case, there are welfare losses due to an increase in financial stability.
Digital Currency and Banking-Sector Stability
Authors: William Chen, Gregory Phelan
From: MIT, Williams College
