WASHINGTON — As the U.S. looks more seriously at issuing a digital dollar, the financial services industry is beginning to raise concern about a future where digital cash crowds out bank deposits.
Though the Federal Reserve has not made a decision about whether to develop a central bank digital currency, or CBDC, its plans to release
“Banks are concerned, mostly because of the unknown,” he said. “At this point, there's so many policy discussions on the role, reason, the need for a central bank digital currency. Banks are trying to figure out from all of those policy gaps where they are [going to fit] in the overall central bank digital currency ecosystem.”
Fed Chair Jerome Powell has said a digital dollar “would serve as a complement to, and not a replacement of, cash and current private-sector digital forms of the dollar, such as deposits at commercial banks.”
Many took that as a signal that the Fed is not interested in a “direct” CBDC model, which would involve the Fed providing holding and maintaining individual accounts for digital dollar holders.
Instead, most believe that if the Fed were to move forward with a CBDC, it would instead pursue an “indirect” or “two-tiered” model, in which digital dollars would be distributed through intermediaries, such as banks or fintech companies.
“It does seem that our central bank wants to preserve the valuable role of financial institutions,” said Nasreen Quibria, vice president of emerging payments and technology policy for the Independent Community Bankers of America.
But that could still have wide-ranging implications for banks. Financial institutions use deposits as a funding source to issue loans, which in turn enables customers and businesses to borrow money. But banks wouldn’t be able to lend out digital dollars, because they would be a liability of the Fed.
“A CBDC is akin to a digital mattress,” said Greg Baer, president and CEO of the Bank Policy Institute. “It can’t be lent out. It’s on the books of the central bank.”
That is a particular concern for smaller banks, which rely more on short-term liabilities in the form of deposits, said Quibria.
“There are concerns about potential migration of bank balances to the central bank if people substitute a CBDC for commercial bank deposits,” she said. “You could have a significant drain on retail deposits, thereby affecting funding ability, which is a critical activity of financial institutions.”
Along with rumblings in the industry, a member of Fed’s own board of governors this week questioned whether there is a compelling reason for the central bank to issue a digital currency.
Fed Gov. Christopher Waller, who was nominated by former President Donald Trump, on Thursday argued there is no specific market failure that a central bank digital currency would address. His comments echoed remarks from June by Fed Vice Chairman of Supervision Randal Quarles, who questioned whether the benefits of a Fed-backed digital currency
The private sector already is developing faster and cheaper payments without the need for government intervention, Waller said.
“What problem would a [central bank digital currency] solve?” Waller asked in a virtual speech at the American Enterprise Institute. “What market failure or inefficiency demands this specific intervention? I am not convinced as of yet that a CBDC would solve any existing problem that is not being addressed more promptly and efficiently by other initiatives.”
Waller laid out several reasons given by proponents as to why the Fed should adopt a digital currency —and prompted refuted all of them. He cited recent estimates that found that just 1% of unbanked households would be interested in a Fed CBDC account.
“It is implausible to me that developing a CBDC is the simplest, least costly way to reach this 1% of households,” Waller said, adding that banks already are promoting financial inclusion through the Cities for Financial Empowerment’s Bank On project.
The Fed's possible consideration of a digital dollar — similar to steps by other countries to explore a sovereign-based digital currency — would not be the U.S. central bank's only foray in payments causing alarm among banks.
Big banks have long criticized the Fed’s decision in 2019 to create its own instant payment system. When it is launched, FedNow will compete directly with the private sector’s own real-time payment solution.
The Clearing House, a payments company that is owned by the nation’s largest banks, has been operating its own real-time system since 2017, and maintained that the Fed’s decision to get involved in instant payments would slow down the long-awaited payments modernization in the U.S.
Dugas said a digital dollar could potentially “eliminate much of the fee and revenue that banks assume today.”
Banks could theoretically pay a higher interest rate on deposits to compel customers to keep their money in deposits, but that could have consequences as well, said Baer.
"Of course, that translates necessarily into an increase in funding rates, so now every loan in the country just got more expensive, which is a drag on economic growth and employment and" gross domestic product, he said.
This pattern could be amplified during a downturn, the American Bankers Association warned in a June 9 statement ahead of a Senate subcommittee hearing on CBDCs.
“In times of economic stress, depositors are likely to prefer holding their money at the Federal Reserve. This creates a risk of bank runs that would undermine financial stability,” the group said.
The Fed likely recognizes this risk and has options for ensuring a digital dollar is not drain on deposits, Quibria said.
“I do believe that in as much as possible, the architecture would be structured in such a way to be able to mitigate some of those issues,” she said.
For example, the Fed could cap the amount of CBDC that an individual can hold, resulting in any cash above that limit likely staying on bank balance sheets as deposits.
“There are features that are being contemplated to make national digital currencies less attractive to, say, flights or hoarding,” said Quibria. “For example, limiting of the amount of a CBDC that could be held by an individual or limiting the overall supply that's injected into the economy to address the leakage of bank funding and the impact to the traditional banking system.”
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A drain on bank deposits "should not be a risk, particularly if the amount of CBDC per household was capped and was issued solely for government emergency support payments,” she said. “Such a system could actually prove beneficial to banks as it would reduce the risk of consumer defaults during severe economic downturns.”
Still, limiting either the use cases of CBDC in the system or the amount a person could hold would likely undermine some of the purported benefits of a digital dollar in the first place. Those include expanding access to the financial system for the so-called unbanked and offering a more stable alternative to private digital currencies. Those are chief among the reasons the U.S. is considering a digital dollar in the first place.
“Any consumer or business that expected to maintain a balance in excess of the limit at any time would still need to establish and hold a bank account, reducing efficiency and financial inclusion arguments for a CBDC,” Baer
Despite banks’ concerns about how the intricacies of a digital dollar could affect their business models, most observers feel that a CBDC in one form or another is inevitable.
“I don't think a bank lobbying on this issue is going to be hurtful to the development of a central bank digital currency,” Dugas said. “Given the breadth of the financial services system overall, the banking regulators, including the Federal Reserve, will have to think through many issues, and I think [banks] can help clarify or identify issues as the public policy debate kind of unfolds.”
Quibria agreed, adding that “it’s not a question of if it’s going to happen, but more when and how.”
“Any form, whether it's two-tier or others, there is going to be impact to all stakeholders, really — financial institutions, other payment providers, fintechs,” she said. “But I do believe that there's also an opportunity for innovation as well.”
Kate Berry contributed to this article.
