A new study by the United States Treasury division has claimed that fully integrating a stablecoin or central bank digital currency (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.
The Office of Financial Research study considered a theoretical “stable state” in the financial sector, after a stablecoin or CBDC had been successfully introduced. The authors of the study see a risk of systemic deleveraging and a reduction in banks’ equity, which could lead to reduced stability in times of crisis after the introduction of a digital currency.
With a stablecoin or CBDC in place in the economy, the study argues that bank deposits would “compete” with the digital currency within households’ liquidity portfolios. That would cause banks to reduce the spread between lending and deposit rates by raising interest paid on deposits, leaving them with less equity than they would have without digital currencies being present.
The study suggests that households would benefit from the competition between banks and digital currency. The authors wrote, “In our benchmark calibration, we find plausible welfare gains on the order of 2% in terms of consumption-equivalent.” However, the study warns that if digital currency competed too well with bank deposits, the resulting financial instability could have a negative effect on households.
The authors also cautioned that “Profit-maximizing issuers in a competitive market” might outperform digital currency in increasing public welfare. The study concluded that “Our results suggest that financial frictions may limit the potential benefits of digital currencies, and the optimal level of digital currency may be below what would be issued in a competitive environment.”
The report’s release comes as the White House released the Economic Report of the President, which also expressed concern over the potentially harmful effects of an economically integrated CBDC on the banking system. The report highlighted the need for more research and development to ensure that any potential economic and financial risks are identified and addressed.
The US Treasury division’s report is likely to stir debate over the potential risks and benefits of CBDCs and stablecoins, as many countries worldwide continue to explore the creation of their own digital currencies. As digital currencies become more mainstream, it is crucial to understand the potential risks and benefits to ensure a stable and resilient financial system.