Will CBDCs Disrupt Banks’ Business Model?

In 2022, the share of central banks involved in some form of work on central bank digital currencies (CBDCs) rose to 93%, according to the Bank for International Settlements. The Bahamas, the Eastern Caribbean, Jamaica and Nigeria have all already issued a live retail CBDC.

However, CBDCs sometimes raise doubts, and even fears, among commercial banks, as acknowledged in a speech by François Villeroy de Galhau, governor of the Bank of France.

CBDCs may compete with banks in providing payment balances and services, potentially causing a reduction in deposit and credit creation.

The main concern for banks is that households will eventually prefer risk-free CBDCs to bank deposits, which represent a stable and cheap source of funding for borrowers. There will be consequences for banks’ ability to meet their prudential requirements and lend to the economy at certain prices.

The lack of deposits will inevitably change the liability side of the bank balance sheet.

“What you want is for the banks to be able to basically maintain their business model as it was. You don’t want to interfere in any way with what the banks are doing on the asset side of their balance sheet,” said Dirk Niepelt, leader of the Center for Economic Policy Research’s Policy and Research Network on FinTech and Digital Currencies, during a joint conference with the European Central Bank (ECB) in November.

How to neutralize CBDCs impact on the real economy

Central banks have a lot of leeway to neutralize CBDC effects on the real economy. It remains to be seen whether CBDCs could lead to a significant loss of deposits for financial institutions. Customers can decide to stick with what they know and are familiar with. The current evidence suggests that despite the variability of interest rates offered by different banks on instant access accounts, most households tend to stick with their current providers.

But if this remains the case, central banks can regulate how attractive a CBDC can be to consumers by, for example, offering non-interest-bearing CBDCs.

When CBDCs and deposits are perfect substitutes, the central bank can offer loans to banks at attractive terms that can offset the potential lost deposits.

Therefore, it may be important that the ECB envisages the digital euro as a means of payment and not as a store of value, suggests the European Banking Federation. This can be achieved by limiting the maximum amount of digital euros in circulation.

Do we really need another CBDC?

There is an open debate about the necessity of CBDCs.

The key reasons for a digital euro are to preserve the accessibility of central bank money, to support monetary sovereignty by limiting the primacy of “external” digital assets, and ultimately to support the “strategic autonomy” of the European continent.

It is not obvious that the world needs a new digital means of payment, says Santiago Fernández de Lis, head of regulation at BBVA.

“Central banks are keen to innovate. They want to create something that is more in line with new technologies. However, before they take that step, they need to be very clear about what type of problem they want to address,” he adds.

One of the most plausible reasons for implementing a CBDC is the idea that Europe needs to maintain “strategic autonomy” from foreign payment-related service providers and credit card schemes, according to Mr Fernández de Lis. However, a central bank digital currency is not the only way to address this problem: the region could instead opt for a domestic retail payment solution scheme, he adds.

There are already payment schemes underway in Europe, and an initiative to establish the European payment scheme, points out Hilmar Zettler, head of banking supervision and deposit protection at the Association of German Banks.

At the moment, the proposals do not focus enough on the wholesale aspect, which makes sense, but rather on a payment scheme managed by the ECB, according to Mr Zettler.

Focusing on a wholesale CBDC to improve the efficiency of cross-border payments will lead to more efficiency gains rather than a purely retail CBDC, adds Mr Fernández de Lis.

“We don’t think the central bank is the right institution to manage a payment scheme, especially considering that it already handles other partially conflicting functions such as banking supervision and central banking,” adds Mr Zettler.