October 23, 2021

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Why banks fear central bank digital currencies

Digital currencies updates

With the summer Olympics in Tokyo winding down, preparations are stepping up for Winter Olympics in Beijing in February. These will ring the starting bell on a much bigger international contest than downhill skiing.

China plans to stake an early territorial claim in the new world of central bank digital currencies. It will give foreigners their first real chance to make payments using electronic renminbi issued by the People’s Bank of China.

Any bankers among the visitors may a feel a chill that sub-zero weather cannot be blamed for. Central bank digital currencies could disrupt their industry significantly.

New forms of digital currencies promise to be easy and cheap to hold and exchange. That gives them potential to rock the power bases of conventional national currencies.

China’s long-running project to develop electronic renminbi is part of a broader challenge to the financial influence of the US. It is also a defensive response to the growth of private payment systems in China, notably Alipay.

Developed democracies also fear their own currencies may be partially displaced by zingier crypto alternatives. They are mulling the creation of their own CBDCs. Feasibility studies are under way in the European Union, the UK and, even more nebulously, the US.

Why does any of this matter to banks? If they can intermediate transactions in pesos and riyals, why not digital currencies? Many US banks are already preparing to deal in bitcoin. In consensual Europe, banks would probably end up stewarding digital euros as they do conventional cash.

The problem is that theorists typically think central banks would need to become retail deposit takers for their CBDCs to gain critical mass. And taking retail deposits has been a core business for bankers in Europe since the Middle Ages.

A deposit account with the European Central Bank or its satellites would look attractive to many Europeans when interest rates were low or financial panic was rife. Central banks in developed economies do not collapse with the risk that customer deposits will evaporate. In contrast, several commercial lenders were wiped out in the financial crisis, including Northern Rock and Anglo Irish Bank.

Paradoxically, central bank CBDC deposits could worsen financial instability for this reason. Suppose that in another meltdown enough terrified depositors switched their funds from the branch of their local bank in the piazza to the safety of the Bank of Italy. The local bank would then be in serious trouble. Around €11tn of deposits could theoretically be vulnerable across the eurozone, according to a study by Andrea Filtri, co-head of equity research at Mediobanca.

Bigwigs such as Fabio Panetta, a board member of the ECB, have suggested capping the amount of digital euros that customers could deposit with central banks. The favoured figure is €3,000, roughly the per capita amount of banknotes in circulation in the eurozone.

Filtri estimates that equates to a maximum reduction of around €1tn in the deposits held by eurozone commercial banks. This would hardly leave them lacking of capital to lend. They have excess liquidity of some €3.4tn.

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Filtri views this capped form of central bank retail deposits as “innocuous” for commercial banks. Marion Laboure, a Deutsche Bank strategist, adds: “I would be more concerned by a lack of adoption than too much of it — it takes time to create a habit.”

The customer inertia that favours banking oligopolies is just one obstacle to CBDCs in developed democracies. Privacy is another. You do not have to be a money launderer to dislike the idea of state bodies being able to see every transaction you engage in. This might be possible with blockchain-based CBDCs.

The issue is jokingly illustrated by one expert with the “cheeseburger transaction declined scenario”. Here, government busybodies “switch off” electronic money an overweight citizen wants to spend on an unhealthy snack.

None of these snags with CBDCs get commercial banks entirely off the hook. The ECB is still contemplating the nationalisation of part of their deposit-taking business. This comes at a time when interlopers are busy trying to prise other lines of business away from traditional lenders. Remittances are just an example.

The business model of most commercial banks bundles multiple services together to create economies of scale. CBDCs figure as one of the innovations threatening to pick that business model apart.

jonathan.guthrie@ft.com

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