A recent study by the United States Treasury revealed that the introduction of central bank digital currency (CBDC) could potentially destabilize the banking sector while also having the potential to boost household welfare.

Before now, US lawmakers expressed dissatisfaction with developing central bank digital currencies (CBDCs). In a new bill, the board noted that the Fed has no authority to develop and issue a central bank digital currency, as it may affect the privacy protection of digital asset investors.

Based on the Office of Financial Research’s study, the effect of these central bank digital currencies could be drastic given the economy’s current condition, and introducing a central bank digital currencies could lead to instability and reduced bank equity.

The research board believes establishing a CBDC or stablecoin in the economy may raise competition between digital currency and bank deposits. This may push banks to increase deposit interest rates to reduce the spread between deposit and lending transactions.

However, the outcome of this action will be reduced equity for the banks. Usually, banks rely on deposits to fund their lending activities, and paying higher rates on deposits could lead to a credit crunch and increased systemic risk. 

However, there are chances that this occurrence will be beneficial to households. According to the research, there will be a slight gain of up to 2% for consumers amid the competition between digital currency and banks. It also noted that the benefit might not last if the competition favors digital currency, as the households will face the heat of the resulting financial instability.

The study also revealed that apart from banks’ destabilization and boost in household welfare, introducing the central bank digital currency may decrease the financial system volatility. This possibility is hinged on asset price volatility dropping after integrating CBDC into the economy.

It added that the financial markets would thrive due to higher prices and reduced volatility. However, given the more significant risks of inadequate capital levels facing the banking sector, the financial industry may suffer.

The study from the Office of Financial Research surfaced at the time the Economic Report of the President came from the White House.

The report expressed concerns about introducing CBDC in the banking system. It added that further development and research are necessary to identify and address the potential financial and economic risks of CBDCs.

The US Treasury report also recommends that the design of CBDCs should complement, rather than replace, existing payment systems. It further noted that appropriate safeguards should be put in place to mitigate the risks of financial instability. As such, it’s vital to carefully weigh the potential benefits and risks before implementing.

Featured image from Pixabay and chart from Tradingview.com

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