Benefits and risks of central bank digital currency

The concept of a central bank digital currency (CBDC), i.e. publicly available electronic money issued by a central bank, has become a hot topic for economists in recent years.
Benefits and risks of central bank digital currency


Some central banks and international institutions are conducting analysis and publishing reports on such currency, and a few central banks in emerging economies have even decided to launch a certain form of CBDC.

Nowadays, central banks tend to restrict access to the electronic money that they issue only to commercial banks. The funds of commercial banks kept in their accounts at the central banks can be used to settle both their own transactions and those of their clients. In contrast, access to cash, i.e. the paper form of central bank money, is available to both banks and – through the banks – to non-banking entities.

The introduction of CBDC by central banks would involve the central bank issuing electronic money that could also be used by non-banking entities, i.e. predominantly households and businesses. Three possible forms of CBDC are proposed most frequently: 1) an electronic record on accounts in the central bank 2) a so-called token in the form of a distributed ledger, or 3) a record on a payment instrument or device (e.g. on a pre-paid card or a smartphone).

At the same time, many specific questions related to the potential operation of a CBDC are being considered. These concern, in the first place, limits on the amount of CBDC holdings and transactions, the universality of access to CBDC, the interest rate on it, the method to settle transactions (directly between the parties to the transaction, through the central bank, or through the commercial banks), as well as their anonymity.

The impact of any CBDC introduction would depend, to a large extent, on the specific form that the given CBDC would assume and the details of its implementation. However, CBDC introduction is often seen as an opportunity to enhance the effectiveness of a payment system, which in many countries leaves much to be desired due to long settlement time and high costs related to an underdeveloped technology and a lack of competition. At the same time, CBDC would provide a response to the emergence of private digital currencies in recent years that may be a source of risk to their users.

In some advanced economies, notably in Sweden, an important reason for the potential introduction of a CBDC amid the progressive squeezing out of cash would be to ensure access to central bank money as an alternative to private cashless solutions. On the other hand, in developing countries, the introduction of a CBDC might limit financial exclusion that concerns a significant part of the population.

In the debate on the introduction of CBDC one cannot omit discussion about cash. Its sharp decline in use in transactions (or even its disappearance), which is expected by some, could provide an argument in favour of the introduction of CBDC. A decline in the use of cash might restrict access to money issued by the central bank for a large part of society. Yet, which is often overlooked, despite the ongoing dynamic growth of electronic payments across the world, in most advanced and emerging economies the value of cash in circulation in relation to GDP is not falling. On the contrary, it is increasing (as evidenced, among others, by economists of the Bank for International Settlements). In the euro area, according to the recently published data for 2019, 73% of transactions (by number) or 46% (by value) were concluded in cash form.

In Poland, according to the December 2019 NBP report “Payment System in Poland”, although the share of cash payments in the number of retail payments has fallen markedly in the last several years, consumers continue to declare that most of their transactions are carried out in cash (57% in 2018; by number of transactions).

In countries where the payment system operates efficiently, its operating costs are low and it provides a high level of security, diversity and functionality for the users (like in Poland), and at the same time cash is still widely used in payments, it is difficult to unequivocally point to benefits from the potential introduction of a CBDC.

Some commentators point out that an additional argument in favour of introducing a CBDC could be the potentially higher effectiveness of the central bank’s interest rate transmission mechanism to the economy. Should a CBDC be introduced on a large scale, the central bank would be able to directly influence the interest rate on the funds of entities holding the CBDC. Yet, while this argument is in principle true, it seems also irrelevant, primarily due to the fact that the current monetary policy transmission mechanism works efficiently. A change in the central bank interest rate is promptly transmitted to the interest rates on deposits and loans in the banking sector.

In this context it is often pointed out that the introduction of a CBDC would enable the central banks to curb or eliminate challenges resulting from the effective lower bound on nominal interest rates. The problem stems from the fact that central banks are not able to cut interest rates significantly below zero due to the possibility of deposits held in the banking sector being converted to cash (the interest rate on the latter is 0%).

However, it should be noted that the elimination the effective lower bound problem would only be possible if cash were to practically disappear. In practice it would probably require a top-down ban on its use. Otherwise, the introduction of a CBDC would not remove the floor for the nominal interest rates – non-banking entities would still have the possibility of converting deposits or CBDC bearing negative interest rates to cash. The elimination of cash from circulation by order, regardless of the assessment of such an action from the legal perspective, would in itself generate significant risks to the credibility of the domestic currency, potentially even leading a flight from domestic currency and dollarisation. Hence, also in terms of the effectiveness of the monetary policy pursued, it is difficult to point out any advantages of a CBDC.

The introduction of a CBDC on a large scale would, however, pose significant threats to the financial system. The introduction of a CBDC might be excepted to urge households and enterprises to convert – at least partly – deposits held at banks into the new form of money. The scale of this conversion would depend on whether the CBDC would bear interest or not, and if so, on what the difference between the interest rate on deposits in the banking sector and the interest rate on the CBDC would be. Yet, regardless of the interest rate level, strong incentives for the conversion could emerge in the case of deposits exceeding the guaranteed amount (i.e. EUR 100,000 in EU Member States) as well as in the case of strong economic shocks and heightened risk. In such a situation deposit holders could strive to transfer their funds to the safe haven that the central bank’s money constitutes.

The outflow of deposits from the banking sector would pose a threat to the stability of the banking sector. Therefore the commercial banks would be forced to seek other sources to finance their lending. A possible solution would involve raising funds through a bond issues. Nevertheless, the reduced share of the deposits – perceived as a stable source of financing – in the liabilities of the commercial banks could increase the pro-cyclicality of lending. Therefore, the banks’ ability to grant loans would depend on acquiring other, less stable, sources of funding. In particular, in the case of increased risk perception, there would be an escalating outflow of deposits from the banking sector and their conversion to the CBDC. As a result, the risk of a procyclical credit-crunch would be higher. Such a situation would be even more likely to take place as the financing in the form of bond issues is more expensive for banks than through deposits. Hence, the costs of lending would also have to rise.

Regardless of the unfolding of such an extreme scenario, the introduction of a CBDC would pose the risk of an increase in interest rates on loans granted by banks. Banks could be forced to raise interest rates on deposits held by households and companies for which the CBDC would offer a direct alternative. As a result, in order to keep the interest margin unchanged, the interest rates on loans would also have to increase.

If the outflow of deposits from the banks failed to be offset by raising funds from the market, it would be necessary for the banks to obtain a loan from the central bank. The collateral for such a loan would be commercial banks’ assets, i.e. primarily the loans granted. Therefore, banks’ lending would largely depend on whether the central bank would grant them refinancing, which in practise would need to be secured by the banks’ credit portfolios. As a result, credit risk would be transferred to the central bank (in case the risks materializes, it would result in losses for the taxpayer), and this in turn, would create a strong incentive for the government to interfere in the lending process.

Money is created as a result of lending. Thus, theoretically, there is a choice as to whether we want money to be created through lending by commercial banks or lending by the central bank, and in particular, lending to the government. It is not without reason, however, that in the modern monetary system money is created by the profit-oriented commercial institutions, notwithstanding the fact that this may generate systemic risk related to excessive lending and an increase in financial leverage in the economy or a pro-cyclical collapse of lending.

These risks may be at least partially mitigated by appropriate regulations and macroprudential policy, as well as by other government and central bank measures. On the other hand, the undoubted advantage of the current system is the fact that credit decisions are decentralised and subject to very strong behavioural incentives that are in principle conducive to a high quality of loan portfolios. While it is true that banks’ management boards are motivated to develop lending rapidly, usually their remuneration largely depends on the banks’ financial results and – often – these results are accounted for in the long-term, e.g. by using share options. Nonetheless, the costs of credit risk can have a very strong adverse impact on the financial results. The bank may earn commission and interest income on the loan, but it may lose a significant portion of the value of the exposure, particularly when the collateral proves to be insufficient. This is why loan applications are usually analysed carefully.

Consequently, bank credit supports efficient allocation of resources in the economy, including effective investment, thus supporting the growth of the economy’s potential. It would be difficult to guarantee such efficiency if the credit process was centralised. All the more so, if the central bank was to directly credit the government, which for obvious reasons could often be procyclical and pro-inflationary. This is why, as a rule, in the developed countries the role of central banks in crediting the economy is limited. In the EU direct crediting of governments is completely prohibited (Article 123 of the Treaty on the Functioning of the European Union). The introduction of a widely used CBDC would significantly disrupt the functioning of the modern monetary system and – by necessity – increase the role of the central bank in credit allocation.

It seems that precisely because of the significant risks, and at the same time the absence of clear benefits of the possible introduction of a CBDC, the officials of the largest central banks (including the Federal Reserve of the United States and the European Central Bank) – despite conducting analytical work – avoid unequivocal declarations about the introduction of a CBDC in their jurisdictions. Consequently, at the moment it is difficult to judge how realistic the introduction of a CBDC by these central banks is, as well as what form the CBDC would possibly take. At the same time, these banks declare that the aim of introducing a CBDC would not be to replace cash, whose issue is one of the main responsibilities of the central banks.

In this context it is also worth paying attention to two central banks that are currently carrying out CBDC pilot tests: the People’s Bank of China and the Sveriges Riksbank. The plans to introduce a CBDC in China should be viewed in the context of the level of development of electronic payments and digitisation of the payment system. Interestingly, in China payments can be made even with the use of face recognition technology, thus requiring neither cash, payment card nor smartphone. On the other hand, in Sweden, the main rationale for introducing a CBDC would be the sharp fall in the use of cash. This fall creates many risks, among others,  the risk of emergence of private monopolies in the payment system, which the Governor of the Sveriges Riksbank, Stefan Ingves, drew attention to. The introduction of a CBDC by the Sveriges Riksbank would therefore represent a pre-emptive introduction of electronic money of a public nature. It would constitute an alternative to cash, which is disappearing, as well as, above all, to payment systems operated by private entities. The latter, due to the network effects and the benefits of economies of scale, display a natural tendency towards concentration and monopolisation of the market.

It seems that the rationale behind the introduction of any form of CBDC could be found mainly in the economies where the payment system is less developed. In these economies, a CBDC could be a catalyst of change, promoting the development of modern forms of payment, reducing financial exclusion and the costs of functioning of the payment system, and in some cases also promoting the use of the national currency. Precisely these motives guided the Central Bank of the Bahamas, to be – as it is believed – the first central bank in the world to introduce a CBCD at the end of 2020, and the National Bank of Cambodia to introduce a quasi-CBDC (which the NBC calls rather a new payment system based on elements of a CBDC). In both cases retail clients were not given the possibility to hold a bank account in the central bank, but only a possibility to create a new e-wallet via the financial institutions. At the same time, access to the new form of money is limited in terms of the amount available and this limit is relatively low. This is why the risks to financial stability arising from the introduction of a CBDC are limited, although so far it is too early to draw full conclusions in this regard.

In conclusion, although the consequences of introducing a CBDC for central banks and economies would largely depend on its design, in countries with a smoothly functioning payment system it is difficult to point to clear benefits related to the possible introduction of a CBDC. At the same time, the introduction of a CBDC could pose serious risks to financial stability due to the outflow of deposits from banks and the increased role of the central bank in crediting the economy. This is why it can be expected that in these countries such money will not be introduced, or will be introduced only in a limited form which will not entail significant risk to financial stability and to the unlimited access of citizens and economic entities to cash and its universal acceptance.


The views expressed in this article are the private views of the author and are not an expression of the official position of NBP.

 The article was based on a chapter entitled “Central Bank in the age of digital finance”, which the authors have prepared for publication in the monograph “Digital finance: informatisation, digitalisation and datafication” edited by L. Gąsiorkiewicz and J. Monkiewicz. The book will be published in 2021 by the publishing house Oficyna Wydawnicza Politechniki Warszawskiej.


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