Commercial banks may have bigger role in CBDC design than expected

Deposit guarantees are the elephant in the room

It is often repeated that the key attribute of a central bank digital currency is that it is as ‘safe’ as cash. Central banks, as agents of government, therefore argue that they should issue CBDCs to provide that safety for their citizens. Central banks around the world, such as the European Central Bank, have created models for issuing CBDCs on the basis of this core premise.

However, when working out how to implement CBDC models, a tricky problem immediately comes to the fore: how will the CBDC interact with the commercial banking system? Since the bulk of banking is concerned with lending and other banking products – such as trade finance – central bankers must come to some form of accommodation with existing commercial banking systems to sustain the economy.

As some citizens will undoubtedly wish to hold the ‘safest’ money there is, even if (as proposed by the ECB) CBDCs will not pay interest, then some level of customer deposits will be withdrawn from the banking system and invested in government-backed CBDCs. Since customer deposits are important to bank balance sheets for providing retail and business loans, such a reallocation will obviously be to the detriment of commercial banks. However, as money is a public good and the use of cash is diminishing (actually saving banks money) to be replaced or augmented by CBDCs, commercial banks will, provided the damage is not too big, just have to suck it up.

Holding limits

One very real question is: does a CBDC increase the potential for ‘runs’ against commercial banks? The answer is a resounding yes. In a panic, an unknown number of bank customers will undoubtedly run to the safety of a CBDC. However, trickier questions include ‘how many citizens will actually jump ship’ and ‘what can be done to minimise the number of deposits that are moved?’ The answers to these questions are not easy to work out.

The design of any CBDC will have to be a delicate dance between central and commercial banks. One approach is to limit the amount of CBDC that a citizen can hold, and this has become the preferred method of controlling CBDC issuance.

At what level should a holding limit be set? A study on this topic analysed the size of a holding limit for a digital euro and estimated, based on evidence from German citizens, that an optimal level might be around €3,000. But that paper also noted that the consensus for the slowly emerging digital pound in the UK is between £10,000 and £20,000 – between four and eight times greater. Why such a wide difference? Are Brits that much more likely to panic than Europeans?

Remembering that Europe is a continent not a country, would the experience from Germany be different for smaller less wealthy euro area countries, such as Bulgaria or Slovakia? What would be the consensus number for a holding limit for the entire European Union? Should there be multiple holding limits?

Deposit guarantees

Deposit holders in European banks have a guarantee of €100,000 under the EU’s deposit guarantee scheme for each individual bank account that the customer operates. That level of guarantee is 33 times the size of the consensus digital euro holding limit. So, if European citizens (and merchants) have a solid guarantee from government, which is much greater than a proposed holding limit and the CBDC does not pay interest, then why would citizens invest in the digital euro?

In this situation, any CBDC holding limit is irrelevant unless it is increased to the same value as the deposit guarantee or the deposit guarantee is reduced to the holding limit. As the deposit guarantee is mostly paid for by commercial banks, it would obviously be beneficial for banks to push for reducing the guarantee. So, expect banks to push for such a reduction. If successful, that would reduce the overall ‘safeness’ of citizens’ deposits.

It makes little sense to discuss CBDC holding limits without also discussing deposit guarantee schemes at the same time. The deposit guarantee is the elephant in the CBDC room.

Patrick McConnell is an academic and consultant in the application of technology to global financial markets.

These issues were further explored in ‘Unlocking the potential of a CBDC ecosystem’, published by OMFIF and Giesecke+Devrient.

Join Today

Connect with our membership team

Scroll to Top