CBDCs, banknotes and bank deposits: the financial stability nexus

This paper explores the financial stability nexus within a monetary ecosystem that has been expanded to include a central bank digital currency (CBDC). The paper examines the new risks associated with the introduction of a CBDC, their mitigants and their potential amplification factors. Economists and academics still seem to be split on the validity of the traditional principle of separating money into two tiers of public and private money, as a structural mitigant of the risks of deposit substitution and banking disintermediation towards CBDCs. The potential amplification of the risks associated with CBDCs through credit-related second-round effects is an additional concern. The systematic study of the risks and mitigants carried out in the paper highlights the importance of partially adapting the two-tier system of money by implementing certain limits, as envisaged in CBDC plans. The endogenous mitigation of the risks through improved bank competition often attributed to CBDCs is uncertain and may be insufficient from a systemic risk perspective. The introduction of exogenous mitigants, like CBDC holding limits calibrated on the basis of a robust methodology, seems instrumental to ensure the consistency of a monetary ecosystem that includes a CBDC. Hence, the paper addresses some fundamental methodological issues related to these limits, such as the rationale for alternative targets for the limits, the influence of disintermediation speed, the time horizons involved in the limitation and adaptation process, and the role of regulatory and market frictions. An illustrative empirical analysis for the Spanish case indicates that financial stability might not be a concern for reasonable levels of CBDC take-up, although the complexity and novelty of this instrument call for a more in-depth analysis in the future.