CBDCs, or central bank digital currencies, have become a hot topic after the global coronavirus pandemic. The traditional currencies became difficult to use because of the virus and this prompted the discussion of digital currencies. Since then, many countries have been looking into the idea of developing their own CBDC.
The US Treasury recently said that launching a central bank digital currency (CBDC) in the country can help boost the stability of the banking sector. The department of Financial Research of the US Treasury had published a research paper on Tuesday, which shared the data about CBDCs.
US Treasury supports a CBDC
This report emerges at a time when there have been concerns about a CBDC weakening banking institutions. Researchers had claimed that bank runs could become more severe because of a CBDC, but the US Treasury’s report dictated that it could actually do the opposite and lower risks for the banking sector.
Moreover, it should also be noted that the paper also highlighted how the financial sector could also benefit from a CBDC. The authors of the paper developed a mathematical model to support the first argument. This model involved banks borrowing money for a shorter time period as opposed to the loans they issue in order to stay protected from insurance risks. These situations could lead to financial instability, which cause a bank run.
CBDC can balance risks
But, the involvement of a CBDC can change things because the chances of a liquidity shock are significantly lower for those who deposit. This would allow banks to offer reduced insurance against a liquidity issue and provide the financial sector with more stability. A CBDC could be used for stabilizing the financial system by adjusting the private financial arrangements instead of leading to destabilization.
The research paper also shed some light on the role of the CBDC for making information available. Without a CBDC, banks that are facing a weak financial positioning can keep it hidden from regulatory authorities and avoid detection. This worsens the situation because it results in a delayed response.
With a CBDC in place, regulatory authorities would be able to detect whether the funds were withdrawn, or converted. They will be able to identify problems quickly and facilitate quiet resolutions. Central banks can also respond to a crisis quickly because of the information they provide
Cost of CBDCs
Another important aspect of a central bank’s digital currency that was explored in the research paper was its cost. The research paper said that they should be allowed to operate freely, which means there should be no caps, or fees involved.
Likewise, there should not be any other restrictions placed on CBDCs in a time of crisis because limiting policies can undermine the attractiveness and potential of these digital currencies. The authors of the research paper also asserted that policymakers could also benefit from the access to information that CBDCs can offer because there is a wide range of use cases of the data obtained.