Central Bank Digital Currency and Bank Risk: Welfare and Policy Implications

Cyril Monnet (), Asgerdur Petursdottir and Mariana Rojas-Breu
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Cyril Monnet: UNIBE - Universität Bern = University of Bern = Université de Berne
Asgerdur Petursdottir: University of Bath [Bath]

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Abstract: We study the effect introducing interest-bearing central bank digital currency (CBDC) has on bank intermediation, risk-taking and welfare. We model a CBDC that competes with bank deposits as a medium of exchange. Monopolistic banks issue deposits to lend to productive investment projects. CBDC does not lead to disintermediation, but it can distort bankers' investment decisions. To retain risk-averse depositors, banks need to compete with a risk-free asset (CBDC), which leads them to adjust their risk exposure and hold a safer loan portfolio. This can lead to overinvestment in risk-free (less productive) loans which is sub-optimal from a social point of view. If depositors are highly risk averse and risk-free projects are scarce in the economy, a CBDC that bears interest may lead to an overall welfare loss. Interest rate on reserves then becomes an important policy tool to crowd-out sub-optimal investment and mitigate banking sector risk.

Keywords: CBDC; interest on reserves; banking; disintermediation (search for similar items in EconPapers)
Date: 2025-02-06
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