Digital Fiats Might Result in Commercial Bank Collapse: Fed Research

Though the central banks can offer direct accounts to people, they are not investment experts.

The Federal Reserve of Philadelphia has warned against the impact of central bank digital currencies (CBDCs) on the banking system and pointed out that it might end up closing the commercial banks.

Titled “Central Bank Digital Currency: Central Banking for All?”, the research paper primarily studied the implication of account-based CBDC’s and their implications on the commercial banks.

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CBDCs are a hot topic among the monetary regulators globally as the threats on the monetary system are prominent form digital currencies especially from Facebook-proposed Libra.

The Fed pointed out the advantages of CBDCs on various fronts as they “represent an important innovation in money and banking history.”

But the negative impact on the traditional financial cannot be overlooked.

“The introduction of digital currencies may justify a fundamental shift in the architecture of a financial system, a central bank ‘open to all’,” the 32-page paper noted. “We consider a framework in which the CBDC takes the form of demand deposit accounts of the public at the central bank.”

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Might cause a serious monetary system crisis

This will allow people to maintain a direct account with the central bank.

The research arm highlighted that such projects can backfire if it ignites a bank run, with sudden withdrawals of bank deposits, resulting in a collapse of the entire system.

“While the central bank is capable of offering the socially optimal deposit contract, just as commercial banks do, we demonstrate that the rigidity of the central bank’s contract with the investment banks leads to different allocations during banking panics,” the paper noted.

“This implies that the central bank’s indirect investment in the long asset is protected from early liquidation by this, either completely deterring runs on the central bank or making central bank runs less likely than runs on the commercial banking sector.”

This echoed a similar warning by the former Bank of England governor who raised concerns of CBDCs on fiat, despite the central bank’s involvement in studies to launch one.

Meanwhile, as China has already initiated trials of digital yuan, other global counterparts are also getting concerned. The US is also aggressively looking into the feasibility of issuing the digital dollar to keep the dominance of the US dollar in trade finance.

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