Introducing aCBDC Would Be aCatastrophe for the Banking System
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pSince the fall of Silicon Valley Bank, a href=https://www.youtube.com/live/R3Dh80OvlXI?feature=shareamp;t=5744 target=_blankmany have/a a href=https://www.americanbanker.com/opinion/deposit-migration-to-large-banks-would-harm-small-businesses target=_blankexpressed concern/a over the risk of deposits leaving community banks for larger institutions. But the risk would be present for all banks, regardless of size, if the Federal Reserve introduced anbsp;central bank digital currency, or CBDC./p
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pBankers should make no mistake: If anbsp;CBDC is introduced in the United States, operations are likely to be anything but business as usual./p
pThe “issuance of anbsp;CBDC,” said a href=https://www.aba.com/advocacy/policy-analysis/aba-comments-on-fed-discussion-paper-money-and-payments target=_blankRob Morgan/a, former vice president of emerging technologies at the American Bankers Association, “would fundamentally rewire our banking and financial system by changing the relationship between citizens and the Federal Reserve.” At its core, anbsp;CBDC would create anbsp;direct connection between citizens and the Federal Reserve — as well as the federal government at large. This rewiring of the system opens up risks to a href=https://www.cato.org/policy-analysis/central-bank-digital-currency target=_blankfinancial privacy, freedom, markets and even cybersecurity/a./p
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pAll banks — large and small — stand to lose if anbsp;CBDC were to be created./p
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pPerhaps in an attempt to appease financial institutions and lessen the impact of such anbsp;radical proposal, the Federal Reserve has a href=https://www.federalreserve.gov/publications/money-and-payments-discussion-paper.htm target=_blanksignaled its preference/a for an “intermediated CBDC,” or anbsp;scheme where the central bank enlists the private sector to maintain CBDC accounts and digital wallets. At first glance, this idea might sound like the private sector is being cut in on the action, but those working in financial services should not be fooled by the bone being thrown here./p
pAs Greg Baer, president and CEO of the Bank Policy Institute, cautioned at a href=https://www.cato.org/multimedia/events/exploring-risks-central-bank-digital-currencies target=_blankan event/a held at the Cato Institute, an intermediated CBDC would mean anything but business as usual for financial institutions. While CBDCs come in anbsp;a href=https://www.cato.org/blog/breakdown-different-cbdc-models target=_blankfew different forms/a, it is important to recognize that they are direct liabilities of the central bank./p
pFor financial institutions, a href=https://bpi.com/a-costly-misunderstanding-about-cbdc/ target=_blankthis distinction means that/a “if anbsp;consumer or business chose to hold anbsp;dollar of CBDC, that dollar is no longer available for bank funding.” In other words, financial institutions will still incur costs due to expenses like anti‐money laundering (AML) and “know your customer” (KYC) compliance, as well as cybersecurity maintenance, but there will be no source of loan revenue to balance those costs./p
pOne might reasonably argue that customers already deposit liabilities of the Federal Reserve in the form of cash into financial institutions with no issue. The trouble with this reasoning is in how money takes different forms./p
pWhen cash is deposited, it is technically transformed into another form of money known as “bank money.” However, if anbsp;CBDC is to exist in anbsp;separate digital wallet in an intermediated system, that transformation would not be taking place. In anbsp;sense, an intermediated CBDC is somewhat akin to cash being held in anbsp;safety deposit box. Banks will maintain the account, but they can’t touch what is inside or have ownership of it — as ultimately, those accounts are maintained on behalf of the Federal Reserve. And in practice, that means financial institutions would not be able to use CBDCs in the way they use cash deposited into savings or checking accounts./p
pFrom this perspective, the worst‐case scenario is one in which banks experience runs as people take their money out of deposit accounts to exchange for anbsp;CBDC. Alternatively, in the best‐case scenario, people simply don’t use the CBDC. Is either scenario one that justifies “fundamentally rewir[ing] our banking and financial system” as a href=https://www.aba.com/advocacy/policy-analysis/aba-comments-on-fed-discussion-paper-money-and-payments target=_blankMorgan/a described?/p
pTo be clear, this issue is not just anbsp;risk for those working in the financial system. Faced with the prospect of losing deposit funding, financial institutions will either turn to raising funds in capital markets (at greater risk and expense) or raising rates on deposit accounts in anbsp;bid to win back lost funds (at greater expense). Either way would likely translate into higher costs of loans for people looking to get anbsp;home, anbsp;car or even just emergency funds to get through anbsp;rough patch./p
pConsidering these factors, Federal Reserve governor a href=https://www.federalreserve.gov/newsevents/speech/bowman20230418a.htm target=_blankMichelle Bowman/a recently warned there are “significant risks in adopting anbsp;CBDC that cannibalizes rather than complements the U.S. banking system.” Elsewhere, officials have scrambled to reduce the risk of anbsp;cannibalistic CBDC by proposing a href=https://www.bankofengland.co.uk/paper/2023/the-digital-pound-consultation-paper target=_blankrestrictions on how much money/a people are allowed to hold or spend. Others have suggested a href=https://www.bankofcanada.ca/wp-content/uploads/2019/05/swp2019-20.pdf target=_blanklimiting the amount of interest paid/a./p
pBut again, if such severe restrictions need to be put in place just to avoid destabilizing the financial system, is anbsp;CBDC something that should be adopted at all?/p
pThe good news is that Bowman is not alone in having concerns: a href=https://www.cato.org/study/risks-of-cbdcs target=_blankOfficials across the Federal Reserve, Congress and the broader public/a have all come to recognize the risks that CBDCs pose. As explained by American Banker’s a href=https://www.americanbanker.com/news/does-the-fed-need-congress-to-authorize-a-central-bank-digital-currency-maybe-not target=_blankKyle Campbell/a, there is still a href=https://www.cato.org/blog/house-hearing-foia-reveals-feds-stance-cbdc target=_blanksome debate/a over whether the Federal Reserve has the authority to issue anbsp;CBDC on its own. However,a href=https://www.cato.org/blog/senator-lee-pushes-back-cbdcs target=_blank more and/a a href=https://www.cato.org/blog/representative-emmer-says-no-us-cbdc target=_blankmore members/a of Congress have taken the stance that the Federal Reserve cannot proceed without anbsp;legislative directive./p
pGiven just how impactful anbsp;CBDC could be, it’s anbsp;decision that should not be left to unelected officials. Regulators may have thrown smaller banks under the bus a href=https://www.youtube.com/live/R3Dh80OvlXI?feature=shareamp;t=5744 target=_blankafter suggesting that/a the biggest banks were unofficially given full insurance on all deposits. However, all banks — large and small — stand to lose if anbsp;CBDC were to be created./p
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