According to a recent paper by the Treasury’s Office of Financial Research (OFR), the integration of digital currencies into the financial system could increase household welfare but spell danger for the stability of the banking sector. The resulting financial frictions, the authors note, could limit the potential benefits of new digital currencies, whether issued by central banks (CBDCs) or private entities (stablecoins).
The study modeled a theoretical financial sector in which bank deposits and digital currencies coexist and households can hold both. Its aim was to determine the implications of full digital currency integration for financial stability by looking at the effect of CBDCs and stablecoins on bank profitability and household consumption.
The findings suggest that the full integration of digital currencies would make banks less profitable. That’s because it leads to a decrease in the spread of bank deposits – the difference between what banks charge customers for loans and what they pay other customers for their deposits. By offering a potential substitute, digital currencies would force banks to raise deposit rates in order to attract customers, thereby reducing their spreads, hurting their overall profitability, and decreasing their financial valuations.
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