Central Bank Digital Currencies (CBDCs) and Their Impact During Crises
- August 14, 2024
- Posted by: OptimizeIAS Team
- Category: DPN Topics
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Central Bank Digital Currencies (CBDCs) and Their Impact During Crises
Sub: Eco
Sec: Monetary Policy
- CBDCs as Safe Havens During Crises:
- Risk of Bank Runs: In times of financial crises, CBDCs could be perceived as safer alternatives to traditional bank deposits, especially uninsured deposits, increasing the risk of bank runs as depositors may prefer holding CBDCs.
- Impact on Deposit Insurance:
- Uncertainty in Impact: The effect of CBDCs on bank deposits and deposit insurance is currently largely unknown.
- Crucial Design Features: The operating models and design features of CBDCs in different jurisdictions will play a crucial role in understanding and balancing the associated risks.
- Factors of Concern for Deposit Insurers:
- Replacement of Bank Deposits: The degree to which CBDCs might replace traditional bank deposits is a major concern.
- Division of Labor: The role division between central and commercial banks in managing CBDCs is crucial.
- Privacy Concerns: The degree of privacy attached to CBDC transactions is another key factor in determining its impact.
- Advantages of CBDCs:
- Finality of Transactions: CBDCs offer finality in transactions, eliminating settlement risk as they don’t require bank intermediation.
- Efficient Global Payments: They provide real-time and cost-effective global payment solutions.
- Financial Inclusion: CBDCs could significantly enhance financial inclusion by offering digital currency options to unbanked populations.
- Mitigating Risks from Private Digital Currencies: As the use of private digital currencies grows, CBDCs could serve as a stable alternative backed by central banks, thus mitigating associated risks.
- Challenges for Deposit Insurers with 24×7 Payment Systems:
- Operational Risks: The advent of continuous, real-time payment systems introduces new operational risks for deposit insurers, requiring a reassessment of risks to depositors and member banks.
- Cross-Border Financial Services: While beneficial for cross-border services, digital innovations could increase risks for insurers, particularly with banks holding a significant share of non-domestic depositors.
- Preparation for Tokenised Deposits:
- Understanding Tokenised Deposits: These are digital representations of traditional bank deposits hosted on a secure blockchain.
- Insurer Readiness: Deposit insurers need to prepare for tokenised deposits by considering modifications to their mandates and coverage.
- Risk Modelling: The risks associated with tokenised deposits must be carefully modeled to determine appropriate fund sizes and premium rates.
Bank Run:
A Bank Run occurs when a large number of a bank’s customers withdraw their deposits simultaneously due to fears that the bank may become insolvent. This mass withdrawal can lead to the bank’s collapse if it cannot meet the sudden demand for cash.
CBDCs: –
Central Bank Digital Currencies (CBDCs) are digital forms of a country’s fiat currency issued by the central bank. They are legal tender and serve as a direct liability of the central bank, similar to physical cash but in digital form.