Digital Dollar Could Threaten Banking Sector, Financial Stability: BoC Research

How to ensure financial privacy remains a major obstacle for CBDCs
Digital Dollar Could Threaten Banking Sector, Financial Stability: BoC Research
People pass the Bank of Canada building on Wellington Street in Ottawa in a file photo. (The Canadian Press/Justin Tang)
Rahul Vaidyanath
Bank of Canada research says a digital currency could reduce deposits held at commercial banks, thus increasing their costs of doing business. Furthermore, a central bank digital currency (CBDC) could raise the likelihood of bank runs—a risk to financial stability—according to a monetary policy expert.  
“The CBDC would directly compete with bank deposits in the market for digital money. As a consequence, there are concerns that a CBDC could substantially crowd out bank deposits, which may undermine financial stability by raising the funding cost and reducing the profitability of the banking sector,” said the BoC in a staff working paper published Feb. 8.
Steve Ambler, professor emeritus of economics at Université du Québec à Montréal, told The Epoch Times on Feb. 20 that if a CBDC was designed to be a good substitute for deposits at private banks, financial markets stress could cause people to try all at once to move their deposits from their banks to the central bank.
“It [CBDC] could somehow encourage a run on the banks that otherwise might not occur,” he said.
A run on a bank has rarely happened in Canada but it happens frequently in the United States, where smaller, regional banks will typically go under.
The Office of the Superintendent of Financial Institutions (OSFI), the federal bank regulator, told The Epoch Times on Feb. 20 that without knowing the design and features of a potential CBDC, it’s difficult to assess possible impacts on commercial banks.
But at a conceptual level, OSFI said those impacts could include higher financial stability risks due to banks losing deposits to the CBDC and being less able to extend loans due to loss of revenue and changing distribution channels for money. 
Mr. Ambler says he could see himself opening an account with the Bank of Canada if a hint of financial chaos emerges in the markets and if the costs of switching were small.
“I presume that people would—even if they’re worried about the privacy issues—consider an account with Bank of Canada to be 100 percent safe.”

Dystopian Possibilities

Concern about impinging on individuals’ privacy has long been an obstacle for CBDCs. Recent history in Canada has provided evidence of how far a government will go to shut people out of the financial system.
“You don’t have to have a tinfoil hat to be worried about the issues of privacy and surveillance, especially in a context where … people who donated $50 to the [Freedom Convoy] truckers suddenly found their bank accounts frozen,” Mr. Ambler said.
James Hickman, co-founder of Schiff Sovereign LLC, in a Feb. 14 commentary added his voice to those who say a digital currency would greatly diminish financial privacy. He warned that with CBDCs, governments can simply deactivate a person’s funds with a mouse click, without having to instruct banks.
“If you hold your life’s savings in the financial system of your home country, you’re already taking an unnecessary risk,” he said in reference to Prime Minister Justin Trudeau’s clampdown on the Freedom Convoy by using emergency powers to “cut the protesters off from the financial system.”
In China, one of the earliest adopters of CBDC, the digital yuan is linked to a person’s digital ID and social credit score. People with low credit scores can even be prevented from purchasing food from a vending machine.
Over 90 percent of the world’s central banks are exploring digital currencies, according to the Bank for International Settlements. CBDCs are another global initiative like net-zero 2050 and a global corporate minimum tax rate.
Canada and the United States are in the so-called “development” phase with CBDCs, according to American think tank Atlantic Council, while digital currencies are being piloted or have been launched in 33 of 131 countries tracked, including China, Russia, India, and Japan.

To Pay or Not to Pay Interest

The BoC posits design features that would increase CBDC adoption but says commercial banks retain a competitive edge.
Private banks, in addition to chequing and savings accounts, offer financial products like mortgages, credit cards, and in-person services at physical locations, which households have strong preferences for, the BoC research notes.
The BoC analysis says that CBDC take-up would greatly improve if it had a network of branches like commercial banks and if it paid a “sufficiently high” interest rate.
But it’s expected that the banks—especially the big ones—would respond.
“We find that banks with higher market shares tend to respond more to the introduction of a CBDC, raising deposit rates by more and losing fewer deposits,” according to the BoC research.
The Canadian Bankers Association (CBA) said last August that CBDCs, like hard cash, should not earn interest and that this would “mitigate adverse financial stability consequences that might arise if banks needed to resort to more expensive and fragile forms of funding.”
According to analyst Atul Bhatia in a report for RBC Wealth Management last August, “If the Fed [U.S. Federal Reserve] were to offer interest on deposits—broadening the digital currency from a simple cash substitute to a digital money supply—then the risk to banks increases exponentially.” 
He added that the Fed would thus be a direct competitor to the banks.
Mr. Bhatia also raised concern over the risk of something going wrong with CBDC software in a centralized system of digital currency.
“The efficiency benefits are real and meaningful, but they simply cannot justify creating a single point of failure in critical payments infrastructure,” he said.
Mr. Bhatia said that the case for CBDC is weakened by the rise of large multinational banks that can deliver many of the efficiencies of a CBDC—albeit at a cost but “without the baggage of centralized control.”

Customer First

Having service locations is vital for CBDC adoption, and the BoC research says that if Canada Post offices were used as service locations, take-up would be similar to what is held in cash.
Rural customers would be expected to benefit more from a CBDC than urbanites since access to bank branches in rural locations is poor, according to the central bank.
Last December, the BoC trademarked the terms “digital dollar,” “digital Canadian dollar,” and “central bank digital currency.” 
A BoC survey on CBDCs last November reported that 82 percent of respondents said the central bank should not even be researching digital currencies and that 85 percent of respondents would not use a digital dollar.
The BoC also received feedback indicating that Canadians believe a digital dollar should not add to financial stability risks and that they value their right to privacy and many were worried that a digital dollar could compromise that right.
The CBA said the added benefits of a CBDC to Canadians “remain unclear.”
Rahul Vaidyanath is a journalist with The Epoch Times in Ottawa. His areas of expertise include the economy, financial markets, China, and national defence and security. He has worked for the Bank of Canada, Canada Mortgage and Housing Corp., and investment banks in Toronto, New York, and Los Angeles.
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