Risks to Commercial Banks from CBDCs (2024)

Many of the Central Bank Digital Currency (CBDC) pilots are focussing on the risks to the financial system from their introduction. Indeed, the Bank of International Settlement specially made “do no harm” to existing “monetary and financial stability” the first of the three CBDC foundational principles for this reason.

The commercial bank sector has risks from retail CBDCs.

Whereas a commercial bank can go bust (as was demonstrated in the 2008 financial crisis) it is usually the Central Bank, as the lender of last resort, who steps in to resolve a banking crisis. The reason for this is that a central bank, as the issuer of a currency, can create more currency if needed. This has been demonstrated by the Quantitative Easing programs that were used to support many economies during the Covid-19 pandemic.

One of the identified risks to commercial banks is that if consumers have access to central bank money (in the form of retail CBDCs), then in the event of a banking crisis consumers could withdraw their savings from commercial banks and put them into safer CBDCs. That way if their commercial bank goes bust, the consumer will still have access to their money.

Indeed, giving consumers access to central bank money could make a bank crisis more likely. If a bank has problems (be they technical or financial), customers with easy access CBDC wallets could trigger a run on the bank even if the problems are temporary.

Another potential risk is an increase in the cost of funding loans. Currently customer deposits are the cheapest way for many banks to fund lending. If customers move their money from commercial banks to CBDCs then this reduction in the deposits at commercial banks could make the cost of funding loans more expensive with knock-on impacts to the availability of credit for retail and corporate customers.

However, it is difficult to plan meaningful experiments to understand customer behaviour. No-one wants to trigger a banking crisis.

One approach proposed to mitigate these risks is by limiting the amount that a customer can hold in CBDC. If this amount is limited, then this will limit the impact on commercial banks from the introduction of a CBDC.

The easiest option is to add a limit to the amount that can be held in a CBDC wallet. For example, the ECB has discussed setting a limit of €3,000 on the digital Euro and early designs for the Japanese CBDC propose a limit of ¥50,000. However, a hard limit would restrict the ability for a customer to automatically load money onto a CBDC as there is a possibility of an amount that exceeds the limit being rejected. It would only be possible to automatically load money onto a wallet (for example social security benefits or the payment of wages) if there were rules in place regarding what to do if the upper limit is exceeded (for example pay the excess into an associated commercial bank account). However, this would limit that ability to use CBDC wallets for financial inclusion – one of the main drivers for retail CBDCs.

One way round this is to set a soft limit with penalties if the upper limit is exceeded: for example, a negative interest rate on all amounts above the upper limit or a penalty amount for every day the limit is exceeded. This would work for temporary balances (for example between the payment of wages and the day the rent is paid) but may not be effective in safeguarding against a bank-run.

Another possibility could be expiring money, any CBDC tokens loaded onto a wallet would need to be spent within a time-period otherwise they would expire. While this could ensure that any money loaded on a CBDC wallet is for day to day spending it could penalise people who are unable to use their wallet, such as those who are in hospital.

An alternative would be to make CBDCs less attractive, by not paying interest on CBDC deposits for example, those this would limit the ability of a central bank to use a CBDC as a means of inflationary monetary policy.

Central Banks are aware of these risks. It is for this reason that they are moving slowly on CBDC adoption and experimenting with CBDC design to mitigate them. However, it would be wise for commercial banks to track these design features and model potential impacts on their business so that any mitigating actions (such as increasing interest rates on savings accounts or providing CBDC wallet overflow accounts) can be planned well before they are needed.