In a recent event, Michelle Bowman, Federal Reserve’s board of governors opined that it is “difficult to imagine a world” where the benefits of a central bank digital currency (CBDC) can justify the “unintended consequences.”
Addressing the audience at Georgetown University on Tuesday, the central banker defined CBDCs as digital liability issued by a central bank in the form of its national currency like the Dollar or Pound. However, she added that this is what constitutes the basic definition, and not all CBDCs have to be essentially built using distributed ledger technology (DLT).
The central banker added that the main benefits of CBDC adoption are often counted to be faster payments and higher financial inclusion. However, the FedNow system already allows instant domestic payments, while financial inclusion is at the highest level possible in the U.S.
Furthermore, Bowman addressed the point of faster cross-border transactions and countered it by highlighting that traditional cross-border payments are slow due to the risks they possess. There are huge risks in terms of money laundering and terrorism financing and even CBDCs would be subject to the same regulation.
However, she suggested that the country should not stop proceeding with the potential development of a digital Dollar. She added that the nation should continue working with the required and appropriate international bodies like the Bank for International Settlements (BIS), the Financial Stability Board (FSB), and the G7 to determine the best course of action.
Adding to her opinions, Bowman suggested that policymakers consider two main “threshold questions” when considering the implementation of a CBDC. The first and the “fundamental question” as she says is what problem are they trying to solve via CBDCs.
Then the second question that policymakers need to consider is whether that problem can be solved by the various traits of a CBDC. In case they can be solved, what unintended consequences will that have on the financial system?
According to Bowman, one unintended consequence of a CBDC could be the destabilization of the U.S. banking system. Hence, policymakers must sincerely consider whether the potential consequences are something they are willing to deal with. The central banker added that lawmakers need to ensure that the digital Dollar will be able to complement the U.S. banking system and won’t “cannibalize” it.
To illustrate her point, she also added an example that goes as if a CBDC were to offer similar or better interest rates than commercial bank deposits, it would have a devastating impact on the banking sector and would lead to a shortfall in money available to lend. This would end up creating a ripple effect that could eventually destabilize the entire financial system.
Summing up her speech, Bowman said the U.S. banking system is a “mature, well-functioning, effective, and efficient system” that supports the nation’s economy and it should be protected from unintended shocks. She added:
It would be irresponsible to undermine the traditional banking system by introducing a CBDC without appropriate guardrails to mitigate these potential impacts on the banking sector and the financial system.
Notably, prior to Bowman, the US Treasury’s report highlighted the same concern. A study by the Treasury division claimed that fully integrating a stablecoin or CBDC into the economy could destabilize banks but improve household welfare. The study warns that the harm to banking caused by digital currencies could be “significant” in times of stress, leading to systemic deleveraging, a reduction in banks’ equity, and reduced stability in times of crisis after the introduction of a digital currency.
While most countries across the globe continue to progress in their CBDC development, the topic has been a major source of controversy in the US for a variety of reasons including privacy and freedom. Previously, the concerns hailed mostly from Republican lawmakers but the recent comments from Democrats have made it a bipartisan issue.