A Central Bank Digital Currency (CBDC) is not good for a country’s financial stability, said the Bank of Korea in its latest report.
Dubbed as ‘Central Bank Digital Currency and Financial Stability,’ the study found that the introduction of CBDC deposits would radically decrease the supply of private credit by commercial banks. As a result, those banks will likely increase their interest rates which will further lead to a decline in their reserve-deposit ratio.
Authors Young Sik Kim and Ohik Kwon reached the said conclusion after considering that central banks will work as account holders. In the current scenario, commercial banks assume the role of safeguarding and managing clients’ fiat assets in exchange for an annual interest rate. A CBDC will likely reduce people’s dependency on commercial banking that can eventually leave them “short of funds.”
“If a central bank launches CBDC with a positive interest rate, both individuals and firms can find it attractive to convert their account balances in the commercial banks into CBDC with the central bank,” wrote the authors. “The banking system could then be drained of the funding for its lending and become unstable, which could damage the supply of credit in the economy.”
In layman terms, the authors discussed a scenario known as “bank panic,” in which clients fire their banks, convert their deposits to cash/CBDC, and leave the commercial banking system altogether.
However, if the central bank lends its CBDC deposits to commercial banks, then it could increase the supply of private credit. As a result, banks could lower their interest rates, which eventually could increase lending at clients’ level.
The South Korean banking report follows the country’s earlier stance on launching a CBDC. In July 2018, the Korean central bank had argued that crypto-fiats would impact their otherwise stable monetary policies, atop risks associated with credit liquidity and legal management.
However, many central banks around the world have expressed interest in introducing or using their national cryptocurrencies. In a BIS report published in January 2019, researchers found that 70% of the central banks were experimenting with CBDC. Out of 63 national financial institutions, 41 were from emerging economies like India and China, while the rest were from advanced economies.
The report also isolated Sweden and Uruguay as the only countries that had come closer to launching their CBDC.
As CCN covered earlier, the reserve banks of the UK, Canada, and Singapore also jointly proposed CBDCs for settling cross border payments.