A research paper published on June 1, 2020, by the Federal Reserve of Philadelphia shows account-based central bank digital currency (CBDC) could potentially replace the role of commercial banks if panic runs are managed and commercial banks are given a level playing field in the money market. This however poses a huge risk, the paper says.

The research titled, “Central Bank Digital Currency: Central Banking for All?” shows that a set of allocations in the private financial intermediation (commercial banks) could easily be replaced by a CBDC. The paper however claims that competition between the account-based CBDCs and commercial banks should be allowed and depositor runs minimized.

The paper is a collaboration of the research wing of the Fed Reserve of Philadelphia, the University of Chicago, University of Pennsylvania and Ecole Polytechnique. It looks deeper on the consequences of introducing a CBDC and its effects on the current financial system.

The paper looked into the introduction of an account-based CBDC system, whereby citizens will have a direct account with the central bank, and the implications of a CBDC on financial intermediation – the role current commercial banks play in the system.

Commercial banks are the major facilitators of maturity transformation – a process that sees short term liabilities converted to long term liabilities. For example, banks take in deposits (short term loans) and transform them into longer term instruments such as mortgages and commercial bonds.

However, banks are liable to bank runs whereby customers rush to withdraw their money all at once leaving the bank strained. Sometimes the deposits cash flow also dries up leaving the bank with no money to lend.

Introduction of an account-based CBDC will offer central banks similar ability to current commercial intermediaries but will have to rely on the “expert knowledge of investment banks” to successfully transform deposits to long term side assets, the paper says.

With a clear and “rigid” partnership with investment banks, central bank may turn a monopolistic as more depositors open accounts with them from the commercial banks.

However, the paper notes a possible risk involved in the implementation of a CBDC. It reads,

“If the competition from commercial banks is impaired (for example, through some fiscal subsidization of central bank deposits), the central bank has to be careful in its choices to avoid creating havoc with maturity transformation.”

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