‘Bank Panic’ And Reduced Lending: Korea Warns Of Central Bank Digital Currency Risks

On February 7, the Bank of Korea (BOK) published a working paper outlining some of the detriments and benefits of issuing a central bank digital currency (CBDC).

According to the BOK paper, the researchers used a “monetary general equilibrium model” to examine the potential affect a CBDC could have on the liquidity of banks, as well as on commercial and central bank deposits in a CBDC account.

The BOK is concerned that introducing a CBDC could create competition between traditional bank deposits and CBDC deposits. If too many people transition at once from traditional deposits to CBDC deposits, this could leave the banking system short of funds. This could have a negative affect on the financial stability of the country.

The BOK explained that with traditional banks, deposits serve as “inside money” that’s backed by private credit, while the CBDC would be “outside money.” Both act as a means of payment and store of value, but while CBDC deposits are essentially risk-free, traditional bank deposits are exposed to the risk that the bank may not be able to meet its withdrawal demand.

In other words, introducing a CBDC could cause “bank panic.” In a traditional fractional reserve banking system, only a fraction of bank deposits are backed by actual cash on hand and are available for withdrawal. A mass shift from bank deposits to CBDC deposits could prevent the bank’s ability to provide funding and credit to individuals, enterprises, and commercial banks that need it.

As an example, the BOK researchers envisioned a hypothetical scenario in which the bank issues a CBDC with a high interest rate that attracts many “individual and firms” to change their funds to a CBDC. As a result, too many would convert their account balances to a CBDC, and the bank would be drained of funding for lending, which damages the supply of credit in the economy.

It’s not all gloom and doom, though. The BOK suggested that there may be ways to issue a CBDC that help the financial economy. The researchers explained that although an increase of the quantity of digital currency could increase the likelihood of bank panic, a gradual transition to a CBDC could decrease this risk:

“[O]nce the central bank can lend all deposits in CBDC account to commercial banks, an increase in the quantity of CBDC can improve financial stability by reducing the likelihood of bank panic via an increase in the supply of private credit.”

The BOK is not the only major bank intrigued about the possibility of issuing a CBDC. In May 2018, the Bank of England published a working paper that discussed three possible models for a CBDC. In August 2018, Thailand’s central bank partnered with R3 and eight financial institutions for a pilot project that included the issuance of a CBDC. And in October 2018, Sweden’s Riksbank penned a report that explored the possibility of issuing a CBDC. 

Nathan Graham is a full-time staff writer for ETHNews. He lives in Sparks, Nevada, with his wife, Beth, and dog, Kyia. Nathan has a passion for new technology, grant writing, and short stories. He spends his time rafting the American River, playing video games, and writing.

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