According to statistics compiled by the Atlantic Council’s “Central Bank Digital Currency Tracker,” as of the end of June, 130 countries around the world have explored the feasibility of central bank digital currencies (CDBCs), up 20 from a year ago. Of these countries, 110 are currently developing, testing, or actually rolling out a CBDC. Taiwan’s Central Bank also published the results of a general-purpose CBDC experiment in June last year. Governor Yang Chin-long also stated at the annual financial information system meeting that the Central Bank will conduct opinion surveys based on these results. The impact on financial intermediaries, financial stability, monetary policy implementation, privacy protection, and financial crime prevention must all be considered. This article will briefly review the connection between a potential CBDC and financial stability.

The digital circulation of CBDCs may increase the risk of bank runs during a financial crisis

There is no doubt that currency issued by a central bank is the safest financial asset, so a general-purpose CBDC is particularly attractive to users hoping to avoid risks, especially when the financial system is under stress. A 2020 report by the European Central Bank (ECB) warned that if a financial crisis caused depositors to lose confidence in the overall banking sector, liquid assets could move very quickly from commercial bank deposits into digital euros. The US Federal Reserve has similar concerns; a 2022 report mentioned that a CBDC could make bank runs more likely or more severe. Once the market enters a panic state, this ability to quickly convert other forms of money into CBDCs may make traditional measures such as macroprudential regulation, government deposit insurance, and access to central bank liquidity less effective, making it difficult for commercial banks to prevent depositors from converting their funds into a CBDC on a large scale.

Of course, these effects may be mitigated through proper planning. For example, it is possible to design a CBDC to not pay interest. Nonetheless, because central bank liabilities are inherently less risky, depositors may prefer the CBDC over bank deposits in a time of crisis. A more effective approach may be to limit the total amount that users can hold or accumulate in a short period of time.

However, circulation information may help promote financial stability

A recent article published in the Journal of Economic Dynamics and Control (JEDC) by economist T. Keister of Rutgers University in the US and his collaborators however showed that the impact on financial stability may not necessarily be entirely negative. This is because circulation can provide information to aid financial stability. Watching the flow of money into a CBDC could provide financial supervisors with clues about the state of the financial system, in particular the confidence of bank depositors.

During times of financial panic, a bank or other financial intermediary has private information about its asset quality and liquidity position, such as sentiment of depositors and other short-term creditors. Unhealthy banks often have an incentive to hide relevant facts (at least temporarily) in order to avoid triggering immediate regulatory action, which can hamper an early response to the crisis. Once the proper timing of handling is missed, the situation may become more dire. The paper shows how observing the inflow of funds into a CBDC could allow regulators to more quickly deduce when a bank run is starting, allowing troubled banks to be bailed out more quickly. Since a run is costly to depositors (for example, loss of interest on early termination of fixed deposits), when depositors expect an effective response, their incentives to participate in the run will be reduced. In other words, a CBDC could be a mechanism to improve financial stability through the signaling effect of a rapid supervisory response when a crisis occurs. In this case, a CBDC could improve financial stability.

From this perspective, the relationship between a CDBC and financial stability is not obvious. Questions like the impact and effects of CBDCs on financial stability, and how to control those impacts through mechanism design, require more discussion and analysis.

The author is deputy director of the Financial Research Institute of TABF.