Central banks and the occult: talers from the crypto

Has the time finally come for central bank digital currencies (CBDCs)? Should central banks offer their own “official” version of cryptocurrencies such as bitcoin? Martin Wolf, respected columnist from the Financial Times, says it has. Others including academics Stephen Cecchetti and Kim Schoenholtzeven argue even if CBDCs are inevitable, now is not the right time for them to be introduced.

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Bitcoin and its close relatives are too volatile to operate effectively as money. They are more like works of art than currencies or commodities. Central banks are more concerned about the competition posed by stablecoins, such as Tether and Facebook’s Diem (formerly Libra).

The Bank for International Settlements recommends central bank digital currencies be offered as a form of digital cash to complement the existing system.”

This fear is curious because stablecoins operate very much like bank deposits. Stablecoins maintain their price stability by maintaining convertibility into more traditional forms of money.

Stablecoins do not necessarily entail one-to-one backing – they just need to preserve convertibility somehow. But this convertibility obligation can create liquidity mismatches and expose them to good old-fashioned bank runs.

Digital payments evolve

Liquidity mismatches explain why banks need lender of last resort support from a central bank and why unsupported shadow banks failed during the global financial crisis.

If CBDCs were only available to the banking system it would probably not provide any more benefit than, say, the Reserve Bank of Australia’s (RBA) New Payments Platform (NPP). The NPP already offers a fast, data-enriched digital payments mechanism.

The Bank for International Settlements (BIS) recommends CBDCs be offered as a form of digital cash to complement the existing system. If so, it’s not clear whether they would replace the many cryptocurrencies currently on offer.

But giving anyone and everyone a deposit at the central bank - public or “retail” CBDCs - would be a whole different story.

Whether these deposits at the central bank would be anonymous or not is a key question. But what are the implications on financial stability and monetary policy if such a policy was introduced?

The mistaken idea that banks “take deposits” may blind us to the potential problems a retail CBDC might cause. Banks are not just financial intermediaries in the common understanding of the phrase. Deposits are the by-product of lending - to offer retail deposits, a central bank would need to become a credit allocator.

Central bank decisions

Would the central bank provide overdraft services to the public as well?

Consider the following scenario which would be potentially problematic for the banking system. Suppose a large proportion of the public draws down their overdrafts or lines of credit to convert this newly created bank money into CBDCs.

If this was done on a large scale it would be akin to a run on the banking system. The central bank would need to step in with equal and opposite purchases of commercial bank assets to offset it.

Depending on the amount of safe assets available, the central bank could soon have an unwieldy portfolio of non-government credit or even equity assets. Possibly on a scale that makes existing quantitative easing policies look like small change.

While we are all destined to hear more about CBDCs in coming years, the exact structure of their place in the existing banking system is still far from certain.

James Culham is Executive Director at ANZ Institutional

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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