Tag: commercial banking

Central Banks Could Monopolize Commercial Banking Sector via CBDC, Says Federal Reserve

A new working paper from the Federal Reserve Bank of Philadelphia indicates that the development of a central bank digital currency (CBDC) may create a fundamental shift in the way banks operate.

The Federal Reserve Bank of Philadelphia’s research department recently released a whitepaper entitled, “Central Bank Digital Currency: Central Banking for All?” which explores how CBDCs might directly transform the banking sector.

According to the paper, CBDC could make banking institutions more competitive with emerging financial technology (fintech) firms and investment banks. The Philadelphia Fed’s report supports the findings of CBDC research by the International Monetary Fund (IMF) released in December 2019.

CBDC Could See Central Banks Poach Commerical Banking Customers

According to the paper, “The introduction of a central bank digital currency (CBDC) allows the central bank to engage in large-scale intermediation by competing with private financial intermediaries for deposits. Yet, since a central bank is not an investment expert, it cannot invest in long-term projects itself but relies on investment banks to do so. We derive an equivalence result that shows that absent a banking panic, the set of allocations achieved with private financial intermediation will also be achieved with a CBDC.”

In other words, a CBDC amounts to giving consumers the possibility of holding a bank account with the central bank directly. The researchers also note that the lack of flexibility within a central bank’s contract with investment banks will also deter bank runs in the event of a financial panic.

The authors of the Fed’s research claim that a central bank’s digital currency could make such an institution be perceived as more stable and this perception of stability could then take hold among depositors. Ultimately this could lead to a monopoly for the central bank in terms of deposits and poses a threat to the “maturity transformation” of the commercial banking sector. In simple terms, CBDCs could allow central banks to secure more short-term sources of finance and deposits and begin offering services like mortgage lending and other types of loans usually facilitated by commercial and investment banks.

Dawn of the CBDC

The catalyst for central banks to develop CBDCs came from the rise and potential of a digital and financial global transformation that could occur through private initiatives such as Bitcoin, Ethereum, and Libra. Since the emergence and increasing traction of these decentralized projects: researchers and policymakers have explored the possibility that central banks can also issue their own digital currencies.

Currently, no central bank has managed to roll out its central bank digital currency, although many are in the advanced stages of their testing with China hinting they will go live this year.

While researchers continue to hypothesis the precise impact a CBDC could have on the global financial sector and the wider world of banking, reports of how they will be developed are conflicting and the effects will not be truly realized until the CBDCs are rolled out.  

Digital Dollars—A Two Tier CBDC Design to Maintain US Currency Dominance

The US dollar is the world’s reserve currency. Controlling the de-facto global currency affords the United States a range of privileges, which includes driving demand for the dollar which sustains the borrowing power of the US and allows them to impose devastating sanctions on other nations.

The inception of cryptocurrencies like Bitcoin, which was essentially built to potentially destabilize and displace the central source of power for our governments—their control over traditional financial systems and monetary issuance—has been a growing concern to the United States. But governments around the world became truly mobilized when Facebook announced the Libra project, drawing the wrath of regulators worldwide who could not allow a platform with two billion users to transact out of sovereign monetary control.

For the United States, contending decentralized digital currency is a particularly pressing issue as their global monetary dominance was already under threat due to China’s expansion and internationalization of the Yuan in its Belt and Road Initiative. In the same vein, China is not about to have its plans usurped by a decentralized currency either, and since last year, one of the hottest developments in the cryptocurrency space has been the mission of Central Banks to develop their own, centrally controlled digital currency. These assets are called Central Bank Digital Currency (CBDC) or, in China’s case, Digital Currency Electronic Payment (DCEP). Ultimately these are digital Dollars or digital Yuan, and being the first to achieve dominance in this space will dictate the new rules of global trade.

The Digital Dollar Project

The Digital Dollar Project (DDP) is the focus of the Digital Dollar Foundation and advocates the need for a CBDC. In their recently released whitepaper, the DDP stipulates that it aims for the US dollar to maintain its global dominance but further warns that the work needs to begin immediately. The DPP also calls for public-private collaboration, including the preservation of the current two-tier system for the spread and distribution of a digital retail dollar.

Source: Digital Dollar Project

But how far along is a US Digital Dollar? The development was a common subject during the recent House Finance Committee hearings held over two sessions. The first session was held on June 11 and featured former CFTC Chair and current Director of the DDP, Christopher Giancarlo. The second session was held on June 17, with Fed Chairman Jerome Powell taking center stage of the discussion on the potential infrastructure of the digital dollar.

Keeping the Power—Two-Tier System

Like cash, the DDP argues that the Digital Dollar should be issued by the Federal Reserve and distributed through commercial banks to the American public. Per the whitepaper, “This US CBDC issued by the Federal Reserve System would enjoy the full faith and credit of the US government, represent the third format of central bank money, and be fully fungible with Federal Reserve notes (banknotes or cash) and reserves.”

As described above, according to the DDP, the main advantage of a CBDC like the digital dollar is the fact that it is a liability of the Fed which (despite all economic logic) still holds the best credit rating—hence using a CBDC would be like using cash distributed through a two-tiered system.

Source: Digital Dollar Whitepaper

In the Two Tier system proposal, the Federal Reserve would be responsible for creating the digital dollars—technical design, anti-counterfeit controls—and then distribute them to the first tier, the commercial banks, which distributes the CBDC to the public.

Public-Private Development

In the second congressional hearing, Federal Reserve Chair Jerome Powell clearly opposed some of the initiatives of the Digital Dollar Project—specifically the need for the digital dollar or a CBDC to be developed through a private-public partnership.

Powell clearly expressed that neither he nor the Federal Reserve was interested in such a collaboration. He said, “The private sector is not involved in creating the money supply. That’s something that the central bank does.” He added, “I don’t really think the public would welcome the idea that private employees who are not accountable solely to the public good would be responsible for something this important.”

From Powell’s statements, it is doubtful that the Fed will ever allow direct private sector involvement in the design and build of the digital dollar infrastructure.

The US Must be First

Within the DDP whitepaper and across the two hearings, there has been a call for haste in CBDC development, citing China’s determination to complete their own DCEP first as well as the reports that the Digital Yuan is actively tested across mainland China.

The whitepaper states that the US will lose their competitive edge and may not be able to create a system that has their values of freedom and democracy at heart if they are forced to conform their development to the soon to be completed CBDC infrastructures of other nations around the world.  

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