Yesterday during a speech, Reserve Bank of India (RBI) Deputy Governor MD Patra discussed how tokenized deposits and central bank digital currency (CBDC) might impact deposit insurance.
Tokenized deposits are a digital version of bank deposits using blockchain infrastructure to process programmable payments 24/7. In a digital world, they compete with stablecoins and CBDCs, although the design is quite different.
From a deposit insurance perspective, most tokenized deposit infrastructures aim to maintain the same deposit insurance coverage as a conventional bank deposit. However, Mr Patra noted that tokenization potentially can amplify bank runs in times of stress.
Hence, the risks posed by tokenized deposits need to be modelled to determine the insurance fund size and premium rates.
If there’s a bank failure, compensating clients might be less straightforward. “With different banks using different technologies there’s also the possibility that tokenised deposits could be held by depositors who are not KYC compliant and not clients of issuing banks,” said Mar Patra. “Consequently, verification of the authenticity and genuineness of claims may prove to be a testing challenge.”
Like the United States, India has a recent history of failing banks. In 2020 YES Bank started experiencing a run and the central bank took it over for a while. It restructured the bank with several other Indian banks taking equity stakes. Subsequently, YES Bank raised additional capital and is still operational today.
CBDC impact on deposit insurance
In an economy with a retail CBDC, if a bank fails, those with uninsured deposits will quickly try to transfer the money elsewhere. The advantage of a CBDC its low risk because it is the liability of the central bank. On the one hand, depositors could just transfer the money to another commercial bank. Alternatively, they could switch to a CBDC.
Hence, the Deputy Governor observed that “particularly uninsured deposits, (would be) 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.”
In other words, if CBDCs encourage bank runs, that makes a bank more likely to fail and hence there’s a higher probability of drawing down the insurance fund.
“The impact of CBDC on deposits and hence deposit insurance is largely unknown as of today,” said Mr Patra. “The operating models and design features of each individual jurisdiction’s CBDC will be a crucial factor in expanding our understanding of the balance of risks.”
