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Bank of England: Central Bank Digital Currencies (CBDCs) Poses a Threat to Commercial Banks

Bank of England (BoE) has issued a Staff Working paper dubbed “Competition for retail deposits between commercial banks and non-bank operator’s two-sided platform analysis,” which suggests that the adoption of central bank digital currencies (CBDCs) can jeopardize commercial banking system and create new severe risks for the financial system.

Commercial banks currently use the conventional- and profitable –business model that relies on the plentiful and low-cost supply of retail deposits, for example from companies cash holding in their current saving accounts and the storage of individuals.  This sustains commercial banks’ net interest margin (NIM) profitability. BoE staff working paper cautions that the CBDCs could jeopardize this situation.

The paper suggests a radical idea that the public could be allowed to access the central bank balance sheet to stash their cash holdings in a personal account. Also, Individuals would also be permitted to make payments and disbursements through the digital wallet. Hence, the “universal disintermediated access” to the central bank’s balance sheet, coupled with the payment service functionalities offered by sanctioned digital wallet service providers, would provide depositors, both retail and corporate, with a likely replacement for deposit account services managed by commercial banks.

The rivalry by non-bank operators can fuel commercial banks’ funding cost thereby hurting their net interest margin levels. It would have serious implications for the commercial bank’s balance sheet, asset side mostly. The commercial banks may have to face consequences of outflow of their retail deposits. It may force banks to reconsider their lending business model. The commercial banks may be forced to adopt a “narrow banking business model whereby their lending activity is entirely reliant on non-insured funding from wholesale and retail investors.”

The paper cites Bank of International Settlements (BIS) March report that likewise suggested that “in times of financial stress, domestic (retail) investors are likely to consider CBDC attractive relative to bank deposits, with many possible side effects… for financial stability.”

On May 18, the BoE published a staff working paper, spotlighting various scenarios of possible risks and financial stability issues of CBDCs. Reportedly, the paper notably found that, after a first approximation, there was no reason to believe that introducing a CBDC would hurt private credit or on total liquidity provision to the economy.

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