'The impact of CBDC on deposits and deposit insurance is largely unknown.'
While central bank digital currency (CBDC) offers significant advantages such as reduced settlement risks and enhanced financial inclusion, they could also become "safe havens" in times of crisis leaving bank deposits -- particularly uninsured deposits -- more prone to withdrawal and may even cause a "bank run", Reserve Bank of India Deputy Governor Michael Debabrata Patra cautioned deposit insurers.
A "bank run" happens when a large portion of customers withdraw money in a brief period, and it is triggered due to fear of an impending crisis.
Patra highlighted that deposit insurers need to contend with the possibility that during crises triggering depositor panic, CBDCs could be perceived as a safe haven, thus rendering bank deposits, particularly uninsured deposits, more prone to withdrawal and hence the risk of bank runs.
"Given the inherent links between such systems and the objectives and operations of deposit insurers, it is expected that the topic of CBDC will continue to grow in relevance for deposit insurers," he said.
Patra also said that the operating models and design features of each individual jurisdiction's CBDC will be key in expanding understanding of the balance of risks. "The impact of CBDC on deposits and deposit insurance is largely unknown."
"For deposit insurers, key factors of interest would be the degree of replacement of bank deposits by CBDC, the division of labour between central and commercial banks, and the degree of privacy attached to CBDC usage", he said.
Additionally, he highlighted that in the medium term, adoption of CBDCs by unbanked people could enhance financial inclusion.
According to Patra, the major advantages of CBDCs are the finality of transactions -- settlement risks are eliminated as there is no bank intermediation – and real-time and cost effective globalisation of payment systems.
Additionally, he highlighted that in the medium term, adoption of CBDCs by unbanked people could enhance financial inclusion.
"As an increasing number of central banks face the risk of large-scale use by the public of private or digital instruments that may not be backed by or denominated in the domestic currency, CBDCs may assist in mitigating this risk by being a central bank liability and a form of digital cash," he said, adding that to the public, they would be an alternative to central bank issued cash and -- to a certain extent -- to private money, such as bank deposits.
Patra also highlighted that with digital payments gaining traction, deposit insurers have to re-evaluate operational risks posed to depositors and member banks from the emergence of these 24/7 payment systems.
"While digital innovations can ease cross-border supply of financial services, they can also increase the likelihood of deposit insurers exposed to member banks with a significant share of non-domestic depositors and additional challenges in the case of a payout following bank default," he said.
"In fact, the increasing ambit of cross-border banking activities makes cross-jurisdiction cooperation between deposit insurers and other financial safety net participants all the more relevant."
Feature Presentation: Ashish Narsale/Rediff.com
