🧑🎓 #STABLECOINS + #CBDC: IMF STABILITY REPORT OCT 2024. PROS AND CONS

#IMF has released this report speaking about CBDC's and its impact in the financial stability.

This paper offers evaluates the potential risks and benefits of central banks issuing their own digital currencies, primarily focusing on how this could impact the overall financial system.

The key findings show that issuing a retail CBDC could have a significant effect on both the central bank's and commercial banks' balance sheets, with various implications:

1️⃣ Impact on the Banking System:

When people use CBDC instead of traditional bank deposits, banks could lose a key source of cheap funding (customer deposits), forcing them to seek more expensive or unstable sources of money. ⬆ loans and ⬇ the ability of banks to provide credit.

In stable times, the effects could be moderate, but in times of financial crisis, the ease with which people can move their money into CBDC could lead to digital bank runs, worsening the crisis. 🆘

2️⃣ Balance Sheet Effects:

If deposits goes ⬇, commercial banks will need to find other sources of funds, which could raise their costs and affect lending.

The central bank may need to lend more to banks or buy assets to keep the system balanced, which could expose the central bank to risks, especially in times of stress. 🆘

So, how can they solve this 2 problems?

First of all taking a look to the CBDC Design. In order to reduce risks, the #IMF suggests that 𝐂𝐁𝐃𝐂𝐬 𝐬𝐡𝐨𝐮𝐥𝐝 𝐛𝐞 𝐝𝐞𝐬𝐢𝐠𝐧𝐞𝐝 𝐭𝐨 𝐛𝐞 𝐮𝐬𝐞𝐝 𝐦𝐚𝐢𝐧𝐥𝐲 𝐟𝐨𝐫 𝐩𝐚𝐲𝐦𝐞𝐧𝐭𝐬 𝐚𝐧𝐝 𝐧𝐨𝐭 𝐚𝐬 𝐚 𝐬𝐭𝐨𝐫𝐞 𝐨𝐟 𝐯𝐚𝐥𝐮𝐞.

Adding to that, they must take care of the policies. Central banks could increase banks' resilience by requiring them to hold more capital, or the central bank could provide more liquidity in times of need.

Some of the benefits about CBDCs creation are pointed in the report:

🔵 Improving Payment Systems: CBDCs can make payment systems faster and more reliable, especially in countries with a lot of cash use. It could also reduce the cost of producing and handling physical cash. 𝐈 𝐭𝐡𝐢𝐧𝐤 𝐭𝐡𝐢𝐬 𝐢𝐬 𝐧𝐨𝐭 𝐚 𝐫𝐞𝐚𝐥 𝐛𝐞𝐧𝐞𝐟𝐢𝐭...

🔵 Financial Inclusion;

🔵 Monetary Sovereignty: A CBDC could help central banks maintain control over their currency, 𝐞𝐬𝐩𝐞𝐜𝐢𝐚𝐥𝐥𝐲 𝐢𝐟 𝐩𝐫𝐢𝐯𝐚𝐭𝐞 𝐝𝐢𝐠𝐢𝐭𝐚𝐥 𝐜𝐮𝐫𝐫𝐞𝐧𝐜𝐢𝐞𝐬 𝐥𝐢𝐤𝐞 𝐬𝐭𝐚𝐛𝐥𝐞𝐜𝐨𝐢𝐧𝐬 𝐛𝐞𝐜𝐨𝐦𝐞 𝐩𝐨𝐩𝐮𝐥𝐚𝐫... Aha! 😁

So, to summarize, the major risks for financial stability stem from the replacement of bank deposits with CBDCs. This would weaken banks by forcing them to seek alternative (and more expensive) funding. The central bank may need to expand its balance sheet by offering more loans to banks or buying assets to maintain stability. Apart from that Central banks have more flexibility in adjusting policies such as setting interest rates, capping CBDC holdings, or adjusting reserve requirements to manage the impact on banks.

But what about a blockchain stablecoin scenario instead?

Stablecoins are issued by private entities and not directly controlled by the central bank. This decentralization reduces the central bank’s direct influence over the monetary system... 𝐓𝐡𝐢𝐬 𝐢𝐬 𝐜𝐚𝐥𝐥𝐞𝐝 𝐥𝐨𝐬𝐬 𝐨𝐟 𝐩𝐨𝐰𝐞𝐫 𝐨𝐟 𝐭𝐡𝐞 𝐛𝐚𝐧𝐤𝐬.

Let's think a bit more about this scenario. If stablecoins become widely used, they could also reduce the demand for traditional bank deposits, similarly affecting banks’ ability to lend. However, since stablecoins are typically backed by assets, they could create liquidity pressures if the backing assets become illiquid or devalued in a crisis, triggering runs.

In terms of finacial stability, stablecoins might be more vulnerable to liquidity crises since they rely on private entities to maintain their peg to a traditional currency. A loss of confidence in a stablecoin’s backing could lead to runs, destabilizing financial markets.

Of course, Central banks cannot easily provide liquidity support to stablecoin issuers, unlike banks, making it harder to contain crises. So we can sy that stablecoins could increase the risk of shadow banking activities, where financial services are provided outside traditional regulatory frameworks, adding more complexity to maintaining financial stability.

Monetary Sovereignty: A CBDC could help central banks maintain control over their currency, 𝐞𝐬𝐩𝐞𝐜𝐢𝐚𝐥𝐥𝐲 𝐢𝐟 𝐩𝐫𝐢𝐯𝐚𝐭𝐞 𝐝𝐢𝐠𝐢𝐭𝐚𝐥 𝐜𝐮𝐫𝐫𝐞𝐧𝐜𝐢𝐞𝐬 𝐥𝐢𝐤𝐞 𝐬𝐭𝐚𝐛𝐥𝐞𝐜𝐨𝐢𝐧𝐬 𝐛𝐞𝐜𝐨𝐦𝐞 𝐩𝐨𝐩𝐮𝐥𝐚𝐫... Aha! 😁

And what about monetary sovereignty?

If stablecoins adoption keeps growing, particularly those pegged to foreign currencies, this could undermine a country’s monetary sovereignty. People may prefer stablecoins denominated in stronger currencies, which could limit the central bank’s ability to conduct monetary policy effectively. 𝐌𝐨𝐫𝐞 𝐩𝐫𝐨𝐛𝐥𝐞𝐦𝐬 𝐭𝐨 𝐭𝐡𝐞 "𝐜𝐞𝐧𝐭𝐫𝐚𝐥 𝐩𝐨𝐰𝐞𝐫"...

I'm pretty sure that CBDCs offer central banks the ability to modernize the financial system while keeping control over monetary policy and financial stability. 𝐌𝐚𝐢𝐧 𝐫𝐢𝐬𝐤𝐬 𝐭𝐨 𝐭𝐡𝐞 𝐛𝐚𝐧𝐤𝐢𝐧𝐠 𝐬𝐞𝐜𝐭𝐨𝐫 𝐦𝐚𝐢𝐧𝐥𝐲 𝐢𝐧𝐯𝐨𝐥𝐯𝐞 𝐟𝐮𝐧𝐝𝐢𝐧𝐠 𝐢𝐬𝐬𝐮𝐞𝐬 𝐚𝐧𝐝 𝐜𝐫𝐞𝐝𝐢𝐭 𝐢𝐧𝐭𝐞𝐫𝐦𝐞𝐝𝐢𝐚𝐭𝐢𝐨𝐧, which can be managed through policy adjustments and careful design of the CBDC.

On the other hand, stablecoins offer a decentralized alternative but pose more significant risks to financial stability, especially in crisis scenarios (longer crisis periods at minimun).

👉 They are less controllable by central banks, and their use can lead to financial disintermediation, liquidity risks, and loss of monetary sovereignty if they gain widespread popularity.

Conclusion

So both scenarios present challenges and problems: CBDCs provide more tools for central banks to manage these risks, whereas stablecoins, though efficient in certain use cases, might expose the financial system to greater vulnerabilities without adequate regulation. Stablecoins give the end user power on their money.

Responsability has a cost. Can people be capable of taking responsibility or do they prefer to have it all handed to them and be more comfortable?