31 August 2022

SUERF: The optimal quantity of CBDC in the euro area

According to our analysis, the optimal amount of CBDC in circulation for the case of the euro area lies between 15% and 45% of quarterly GDP. Optimal CBDC rules are effective in mitigating the risk of bank disintermediation and induce significant welfare gains.

Early evidence from an event study suggests that the expected impact of issuing a digital euro on bank profitability and lending depends on the bank’s reliance on deposit funding and the amount of digital euro in circulation. This is due to a perceived degree of substitutability between central bank digital currencies (CBDCs) and bank deposits, which in normal times are a relatively cheap form of bank funding. In this SUERF policy note we use a macro-banking DSGE model calibrated to quarterly data of the euro area economy to investigate optimal CBDC rules.

In recent years, the use of cash for transactions has significantly declined, while the demand for digital means of payment for retail purposes has steadily increased (Auer et al. 2020). In response, central banks have started to investigate the implications of issuing central bank digital currencies (CBDCs). One of the important challenges of issuing a CBDC is the risk of bank disintermediation through deposit substitution (Carapella and Flemming 2020; Niepelt 2021). Much of the current policy debate focuses on how to calibrate the amount of CBDC in circulation to ensure that the potential benefits of CBDC materialize without harming monetary and financial stability through bank disintermediation (Bindseil and Panetta 2020; Jamet et al. 2022). One challenge in this regard is that advanced economies have no experience with CBDCs and, hence, there is no available data on which empirical analysis can be performed. For this reason, the literature has focused mainly on studying the implications of CBDCs within theoretical models.

In this SUERF policy note, we present some novel empirical evidence on the expected impact of CBDC on bank profitability and lending behavior and report on the development of a quantitative DSGE model that allows us to investigate the relevant trade-offs. The findings underscore the importance of adequately calibrating the amount of CBDC in circulation.1 

Evidence: The impact of digital euro news on bank stock prices and lending behaviour

Early empirical evidence on the impact of digital euro news on bank stock prices and lending behaviour suggests that market participants perceive a certain degree of substitutability between deposits and CBDC and that the extent to which this may have a bearing on banks’ lending conditions depends on their reliance on deposit funding and the design of the CBDC.

The response of bank valuations to news about the digital euro project provides insights as to what market participants expect the effect of a digital euro on bank profitability to be. Figure 1 shows the cumulated impact of digital euro news on abnormal returns on euro area banks’ stock prices. Banks’ valuation decreased after the ECB stated its intention to intensify work on a digital euro in early October 2020 (ECB 2020a; ECB 2020b).2 The drop was concentrated among banks with a higher reliance on deposit funding, and was later reabsorbed in early February 2021 when potential limits on individual holdings and other qualifications about the digital euro project that may mitigate deposit substitution were conveyed to the public.3

The reaction of stock prices may have conveyed information about the impact that the digital euro project may have on the business model of banks that rely heavily on deposit funding. Moreover, an adverse assessment by market participants as to the prospects of a given bank in a world with a digital euro may have also directly translated into more expensive market-based funding options for that bank, ultimately exerting pressure on bank lending conditions. Developments in corporate loan markets measured with transaction level data from AnaCredit (the European credit register) suggest that one percentage point drop in stock market returns attributable to digital euro news was associated with a decrease in loan volumes of over 0.3% (Figure 2). Consistent with the recovery of stock market returns observed since early February 2021, the impact on lending disappeared following the discussion of possibly restricting the amount of CBDC in circulation. ... more

Author(s): Lorenzo Burlon, Carlos Montes-Galdón, Manuel A Muñoz, Frank Smets

full paper

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