A recent paper by De Nederlandsche Bank (DNB) explored the transition period after the launch of a central bank digital currency (CBDC). If demand for the CBDC is quite high, then the transition could be disruptive because deposits flow out of the banking system.
The economists explored various options to smooth the transition and found specific holding limits are the best interim solution. A figure of €3,000 works. After the transition period, they find that a CBDC is a net positive for welfare in a steady state and doesn’t disintermediate banks.
Previously the European Central Bank (ECB) floated the idea of a €3,000 limit. However, an updated draft of the digital euro legislation published in early February transfers the decision on limits from the ECB to banks and other payment providers. Hence, the limit will differ between banks, with non-banks likely offering far higher limits.
On the point of not disintermediating banks, the Bank of Canada conducted research that concluded the impact on bank deposits would be 12%. Hence, banks will not be disintermediated.
The Dutch CBDC transition research
The Dutch research assumed that banks have a monopoly on deposits before introducing a CBDC. In response to a CBDC, they react by raising deposit rates. Whether bank deposits rise or fall depends on the demand for a CBDC, which doesn’t offer interest.
If demand is high and overshoots the steady state figure, then bank deposits are attracted away. That has a knock-on effect on lending, reducing the overall welfare of the economy. On the other hand, if demand isn’t that high, then it doesn’t significantly impact bank deposits.
Several tools are available to central banks to smooth the transition period. These include holding limits or penalizing high holdings by charging negative interest rates beyond a certain level, amongst other avenues. Holding limits at around 40% of steady state demand were found to be optimal.
The DNB models predict that once CBDC adoption settles down, deposit rates and overall bank deposits will be higher than before the introduction of the CBDC.
