OFR says central bank digital currency helps households, hurts banks

The Office of Financial Research issued a report Wednesday that found a central bank digital currency, if fully implemented, “household welfare improves, yet banking-sector stability suffers.”

Samuel Corum/Bloomberg

WASHINGTON — A working paper published Wednesday by the Treasury Department’s Office of Financial Research highlighted the benefits of a central bank digital currency for consumers but noted that such an innovation would present “financial frictions” for the banking sector.

The study models and observes a theoretical financial system where both bank deposits and digital currencies are integrated into and widely used in the financial system. The report concluded that the adoption of digital currencies may spell a tug-of-war between bank business interests and financial and household stability.

“Financial system volatility decreases when digital currencies are fully integrated, and household welfare improves, yet banking-sector stability suffers,” the report said.

Under the report’s modeling framework, with increased take-up of central bank digital currency, or CBDC, bank deposit spreads shrank, rendering banks less profitable and making banking sector crises more likely.

“Lower deposit spreads limit banks’ ability to recapitalize following losses,” the report said. “In addition, because banks are less able to rebuild equity after adverse shocks, banks, on average, have lower equity. Accordingly, bank valuations decrease significantly. As a result, the probability the banking sector is in crisis or a distressed state can grow significantly.”

By contrast, households — and the broader financial system — would see potential benefits despite the increased likelihood of banking crises.

“Household welfare could increase by 2% in terms of consumption, even though at this level of digital currency, the probability of crises doubles,” they wrote in their findings.

The OFR paper gives credence to the idea that digital currencies — particularly a central bank digital currency — could lure capital away from banks as people turn to the unmatched certainty of federally issued funds. This is good for the overall stability of the financial system, but means banks would need to restructure their investment portfolios and reduce risk to avoid a crisis.

“[Decline in volatility is] primarily reflected in a decrease in the volatility of asset prices,” the OFR report said. “While financial markets improve with lower volatility and higher prices, the financial sector suffers because the banking sector is at greater risk of insufficient capital levels.”

A relatively new agency, the office has provided financial research expertise to the government since its creation with the passage of Dodd-Frank in 2010. The agency’s funding was cut and it experienced staff reductions under the Trump Administration, but it has seen new functionality during the Biden administration, including assisting the Treasury and the Financial Stability Oversight Council in identifying areas of financial risk. 

The OFR report also comes as the Federal Reserve and Congress debate the utility of developing a CBDC. Banks and some officials have been skeptical that a CBDC would be useful enough to justify the cost, while other administration officials have touted the benefits of developing a digital dollar.

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