15 November 2023

SUERF's Meller, Soons: How would banks respond to central bank digital currency?

In our paper Meller and Soons (2023) we model and simulate a CDBC introduction to inform the debate on holding limits and the impact of CBDC on banks’ funding structure, collateral availability and the central bank balance sheet.

We assess the impact of a central bank digital currency (CBDC) on the balance sheets of banks and the central bank. To do so, we build a constraint optimisation model in which banks minimize their funding costs subject to their own liquidity risk preference, reserve holdings and collateral availability as well as those of all other banks in the banking sector. We quantify the impact of a fictitious digital euro introduction in 2021 using actual balance sheet data of over 2,000 banks and find that a hypothetical €3,000 holding limit would have contained the impact on banks’ balance sheets and the Eurosystem balance sheet. With our simulation and for a given digital euro demand or holding limit, we can identify those banks which would experience an extraordinary increase in wholesale or central bank funding reliance and those banks which would be short of eligible collateral. In our sample, the few identified banks primarily belong to the group of banks classified as less significant institutions, diversified and retail lenders. Those banks might need special attention by prudential supervisors. For central bankers, primarily the model’s mapping between CBDC demand and additional reserves that central banks would need to provide under our assumptions is of interest.

Central banks throughout the world are investigating the potential benefits and risks of introducing a retail central bank digital currency (CBDC). A retail CBDC is a digital form of public money, issued by the central bank and accessible to individuals. Just as banknotes, it can be used as means of payment and store of value, with the benefit of being digital. These features also make a retail CBDC a close substitute for (overnight) bank deposits. However, a CBDC differs from bank deposits in that it is a direct liability of the central bank rather than a commercial bank.

Due to their high degree of substitutability, a successful retail CBDC would lead to retail customers shifting part of their deposits away from their bank to their central bank, possibly at a very high speed. Often-cited financial stability concerns in this regard are the possibility of a bank run or a subsequent increase in banks’ liquidity risk if banks replace the outflowing stable retail deposits with more flighty wholesale funding or drain their central bank reserves (Eurosystem, 2020). With this in mind, and to facilitate a smooth CBDC introduction, central banks debate about CBDC design features, such as holding limits, to control CBDC demand.

In our paper Meller and Soons (2023) we model and simulate a CDBC introduction to inform the debate on holding limits and the impact of CBDC on banks’ funding structure, collateral availability and the central bank balance sheet. Pioneering work by Brunnermeier and Niepelt (2019) explains that banks are unaffected by a deposit outflow into CBDC if the central bank redirects liquidity back into the banking system under favourable conditions (an “equivalence result”). In practice, however, we expect banks to be impacted, for instance because of liquidity regulation and collateral requirements. Hence, our contribution is twofold. First, compared to existing impact assessments of CBDC on the banking sector, our model more accurately reflects the complex interactions between bank balance sheets, the central banks balance sheet and regulatory liquidity and collateral constraints.1

Our second contribution is our empirical application and the policy relevance of our results. Using our model and proprietary bank-level data from more than 2,000 euro area banks, we simulate the impact of a fictitious digital euro introduction in 2021. Our results indicate at what amount of deposit outflows the impact on liquidity risk and bank balance sheets would have been concerning. We find that with a hypothetical €3,000 digital euro holding limit per person, the changes to banks’ funding structures and their liquidity risks would have been moderate, and no additional central bank funding would have been needed. Our model can also be applied to other jurisdictions....

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