Central Bank Digital Currency and Financial Fragility

How does the introduction of a remunerated Central Bank Digital Currency affect financial stability? To study this issue, we introduce CBDC in a global-games model of financial intermediation with an endogenously determined probability of bank runs. Consistent with widespread concerns among policymakers, we show that higher CBDC remuneration increases the withdrawal incentives of investors, and thus bank fragility. However, the bank optimally responds by offering more attractive deposit rates in order to retain funding, which reduces fragility. Accordingly, the overall relationship between CBDC remuneration and bank fragility can be U-shaped. We also study the effects of CBDC holding limits for fragility, deposit rates, and optimal remuneration.

About: Toni Ahnert