Researchers: Retail CBDC could unequally burden small banks

Federal Reserve researchers say a retail central bank digital currency could disproportionately harm community bank lending. 

Published Nov. 21, the report was based on previous research into the concept of a retail CBDC, which is a government-backed digital currency used by businesses and consumers. The researchers cited a working paper published last spring that found larger banks were better positioned to adapt to a CBDC. According to the report published by the Institute for Advanced Studies, larger banks already have more access to wholesale funding than smaller banks, making them less reliant on retail deposits. 

“The authors estimate that the negative impact of CBDC on bank lending for small banks could be three times as large as that for large banks, even though the effects on deposits are similar,” wrote Federal Reserve researchers Sebastian Infante, Kyungmin Kim, Anna Orlik, Andr’e Silva and Robert Tetlow. “The associated deterioration in credit availability might be particularly severe for small nonfinancial firms, given that the empirical literature has established that small nonfinancial firms rely disproportionately on small banks for credit.”

Though researchers said a CBDC could reduce financial friction and improve the payment system, it also carries the risk of bank disintermediation, associated loss in bank credit and potential adverse impacts on financial stability. Allowing consumers to easily convert commercial bank deposits into a CBDC could cause a run on commercial banks during financial system stress if the cost of shifting funds between bank liabilities and a CBDC is sufficiently low. 

“While many types of CBDC could be benign in their implications, a new central bank liability could disrupt the current financial structure, much of which is built on the unique way in most jurisdictions in which banks have access to the central bank,” the researchers wrote in the 34-page report. “The extent to which any such disintermediation would negatively affect lending depends on the viability of alternative sources of funding for banks and on alternative sources of credit for households and firms.”

The impact of a CBDC will likely depend on its design, the researchers noted. Design considerations could include whether the CBDC is held directly by households or nonfinancial firms, whether it is token-based or account-based, or whether it is disintermediated through nonbanks or banks. Another crucial consideration is how the central bank will offset losses in bank reserves due to CBDC-driven outflows from the traditional banking system. 

The researchers said an interest-bearing, intermediated retail CBDC would resemble the Federal Reserve’s Overnight Reverse Repurchase program by allowing nonbank counterparties to directly hold Fed liabilities digitally. 

 “To garner the network externalities that would make it successful, a CBDC would presumably have to be widely adopted and used as a means of payment,” they wrote. “But the more remunerative it is to hold CBDC, the more viable it becomes as a store of value for households and firms.”

The report was released as CBDCs remain a contentious topic. On Oct. 27, Fed Vice Chair for Supervision Michael Barr said the agency was continuing to speak to stakeholders and undertake research into emerging technologies that could support CBDC payments. The Federal Reserve has not made a decision on issuing a CBDC, and is expected to proceed only with direction from the executive branch and Congress. On Oct. 26, Federal Reserve Gov. Christopher Waller said he was unconvinced that a CBDC is needed to maintain the dollar’s preeminence in the global economy. 

Support for a CBDC remains split among party lines. House Financial Services Committee Chair Maxine Waters (D-Calif.) said a digital dollar would ensure the benefits from the dollar’s global role will remain even as other countries, including China, introduce their own CBDCs. In February, House Majority Whip Tom Emmer (R-Minn.) introduced a bill that would ban the Federal Reserve from directly issuing a CBDC. The bill would also require the Federal Reserve Board to consult each Federal Reserve bank about the development of a CBDC study or pilot program and issue a quarterly report to Congress on their findings. Emmer’s bill passed out of the House Financial Services Committee in September and has been introduced to the House floor.