Banks and stablecoins could lose while consumers gain if the Federal Reserve gets approval to digitize the dollar.
The Fed outlined its thinking on a central bank digital currency, or CBDC, in a highly anticipated report on Thursday. Although the report does not make policy recommendations, it presents a plan to turn the dollar into a digital asset. The report also seeks public comment on a CBDC and says the Fed will not proceed without “clear support” from the White House and Congress, ideally in the form of legislation.
The report is likely to spark a debate in Washington and could build momentum for legislation allowing the Fed to start working. Many Democrats in Congress have shown support for a CBDC, arguing that it could help reduce transaction costs for consumers and benefit millions of “unbanked” people who do not have bank accounts, paying fees. high fees for cashing checks and other services.
Some Republicans have also expressed support for a CBDC, saying the United States should digitize the dollar to compete globally with China and other countries that turn their currencies into digital assets. More than 85% of central banks are working on digital currency projects, including the European Central Bank, which is studying a digital euro.
Congress already has a bill to work on: A bipartisan bill, called the 21st Century Dollar Act, was introduced in the House last year by Rep. French Hill (R-Ark.) and Rep. Jim Himes (D-Connecticut).
Yet while a CBDC may be welcomed by consumer advocates and attract U.S. economic interests overseas, it also has its enemies.
The banking sector, in particular, could face more competition if the Fed starts competing for consumer deposits and payment services. And the banking lobby is sounding the alarm.
“An American CBDC could fundamentally reshape our banking and payments system that is still the envy of the world,” the American Bankers Association said in a statement Thursday. “Policymakers would have to show that a US CBDC would somehow improve this trusted and tested retail banking system…and we believe that will be very difficult to prove.”
Banks say they could face more competition from the Fed for consumer deposits. This, they say, could increase lending costs and leave less capital to make loans and extend credit. The Fed could also pressure banks to raise interest rates on deposits, affecting their profitability.
“If I was the CEO of a big bank, I wouldn’t be in favor of this, my shareholders might get lower profits,” Darrell Duffie, professor of finance at the Stanford Graduate School of Business, said in an interview. . “The more efficient a CDBC is, the more existing banking franchises in the areas of payments and deposits are disintermediated and made less profitable.”
Banks could provide most, if not all, of the benefits of a CBDC, Duffie adds. “But it’s not in the interest of the banks to do that, because banking is not a 100% competitive industry and the banks are not interested in a way that would deliver the services and benefits in terms of costs of a CBDC.”
The Fed seems open to solutions that could mitigate the disruption to banks. He said in his report that banks could act as intermediaries for a CBDC, providing digital wallets and interacting directly with consumers. CBDCs might not bear interest or pay less interest than banks on deposits. And there could be limits on CBDC deposits so banks don’t lose much, if any, of their deposit base.
Consumers, on the other hand, could benefit if the risk of losing deposits to the Fed causes banks to raise the interest rates they pay or cut transaction fees. Banks are now paying nearly zero percent interest on deposits, due to ultra-low rates set by the Fed.
Banks could also face competition for CBDC wallets from non-bank fintechs. The Fed noted that “non-bank financial service providers” could be a conduit for a CBDC. This could open CBDCs to any business with a money transfer license, including some of the biggest names in tech:
(symbol: PYPL), Square (SQ),
(AAPL), Google (GOOGL),
Opening up CBDCs to fintechs could also be a win for consumers, Duffie says, as it could make a CBDC interoperable across payment platforms, expand competition for services, and potentially reduce fees for consumers.
A CBDC can also pose a dilemma for stablecoin issuers; this could be a source of competition in areas where stablecoins are already in use.
Stablecoins are thriving as substitutes for digital dollars in crypto markets, used as parking for trading, borrowing and lending activities. Over $140 billion worth of stablecoins are in circulation, mostly USD Coin and Tether. They are also gaining traction for international money transfers or remittances.
Many companies are also working on proprietary stablecoins, including
(JPM), PayPal, and Meta (through its long-delayed Diem project). A CBDC could compete with these privately issued coins for deposits and other financial services.
A CBDC could remove money transfer activities from stablecoins. And if it was interoperable across different blockchains, it could be used to buy and sell things like video game assets and non-fungible tokens.
The Fed has also indicated that a CBDC could provide superior liquidity and lower credit risk than privately issued stablecoins. And it could help mitigate some of the market stability risks now associated with stablecoins.
“In our rapidly digitizing economy, the proliferation of private digital currency could pose risks to both individual users and the financial system as a whole,” the Fed said. “A US CBDC could mitigate some of these risks while supporting private sector innovation.”
We are still a long way from a CBDC making a dent in the US monetary system. And in some ways, a CBDC would just be an extension of the e-money we already zap through apps like Zelle and PayPal. But a CBDC would have more functionality, including the potential to be programmed, like other digital assets. And it could speed up real-time settlement of things like checks that now take days to clear.
Given the rapid evolution of technology, the Fed may have no choice but to digitize the dollar. It’s just a matter of time.
Write to Daren Fonda at [email protected]