Currency cure: Should the Fed and the BOE adopt an “Atlantic Declaration” on CBDCs to avert further banking crises?

Currency cure: Should the Fed and the BOE adopt an “Atlantic Declaration” on CBDCs to avert further banking crises?

By Leon Gauhman, chief strategy officer and chief product office for product design consultancy Elsewhen

In the global race to launch a central bank digital currency (CBDC) and revolutionize the way we transact and store value, the US Federal Reserve (the Fed) and the Bank of England (BOE) are lagging. The Fed is still at the research stage of thinking about CBDCs, while the BoE’s consultation paper is unlikely to result in a digital pound before 2030. Meanwhile, the European Central Bank, which has to navigate the disparate opinions of 27 EU member states, could launch a digital euro as soon as 2027.

The regulatory, structural and political complexities of switching to an entirely new digital currency are irrefutable. Nevertheless, the Fed’s and the BoE’s leisurely approach to CBDCs fails to recognize the critical role that CBDCs could play in steering the banking sector to calmer waters. With bank share prices still volatile and many balance sheets too dependent on bonds and the overleveraged commercial property sector, the worst of the banking crisis may still be to come – with more Silicon Valley Bank (SVB) and Credit Suisse-style casualties on the cards. Far from being a “solution in search of a problem”, this is the kind of scenario that CBDCs could help to avert. With the US and UK recently illustrating their historic bond through the launch of an ‘Atlantic Declaration, ‘ the Fed and the BOE should seek to align the introduction of their respective CBDCs to restore global economic stability for the following reasons:

1. Enhanced oversight and better decisions: The banking system is report-based and opaque. As a result, central banks and regulators come to crises late, having to react to the kind of implosions we have seen with SVB and Credit Suisse. CBDCs mean money and financial instruments become ‘code’. If adopted, they could provide a backbone to the monetary system that would give central banks a much clearer insight into banks’ positions and a better overview of the monetary system as a whole. With a transparent CBDC-powered system, the Fed and the BOE could see what is happening within banks in real time, with early warning systems prompting responsive rather than reactive decision-making.
2. Transparency over policy impact: Central banks have intervened frequently over the last two decades, with quantitative easing and interest rates deployed so often that the sector has developed vertigo. Moves such as the BOE considering overhauling the deposit guarantee scheme following SVB’s rapid collapse suggest central banks seek greater control over the financial system. Introducing CBDCs would provide a better understanding of the impact of such interventions. If the whole monetary system is code, central banks could run simulations, and stress test the impact of their decisions in different scenarios before taking action. For example, a central bank could ask, “What happens to small banks’ balance sheets if we increase the interest rates to X?”
3. No more ‘bank run’ headlines: Nothing creates panic quite like a bank run, with customers fearing for their deposits and the media feeding off that anxiety. In the era of CBDCs, however, it becomes possible to break up the role of banks and take away their responsibility for deposits. Customers don’t need a safe if money is digital because it’s all recorded on the CBDC’s distributed ledger. This makes the bank’s role as a middle link in the chain between the money created or taken out of the system redundant because a distributed ledger-based system doesn’t need anyone to manage payments or run a ledger. Functions such as underwriting would still be needed, but these could be done digitally or by AI. If there is no custodial role for banks, this greatly reduces the risk of a bank run.
4. A coordinated Fed/BOE move: As recent bank collapses demonstrate, banking crises know no borders. What starts in one country rapidly spreads to others. With another potential global banking crisis looming, there’s an opportunity for the Fed and the BOE to develop a coordinated approach to implementing CBDCs that could help mitigate systemic risks arising from the interconnected nature of the global financial system. This could take the shape of sharing advanced information about the health of the financial system and collaborative stress testing, including playing out different scenarios on a global scale. This co-operative approach could minimize the chances of another local SVB-style crisis migrating to other markets, helping stabilize and control the international financial system. There is also the opportunity for the BOE and the Fed to work together on robust protocols to defend a CBDC-based financial system against cyber attacks.

Final Thought:

Already, it’s possible to imagine Fed and BOE decision-makers nodding sagely and putting the question of CBDCs in their pending piles. It doesn’t need to be that way. The current time frame for launching CBDCs is years long. But the next banking crisis will require a much faster response. Even if they can’t avoid the next banking crisis, there is an opportunity for the Fed and the BOE to use such a crisis to fast-track CBDCs in a similarly agile way to the rapid introduction of genetically modified vaccines to combat Covid.

The technology to enable CBDC roll-outs already exists and could be adapted rapidly. What’s missing right now is the political and economic will to do it. In a similar way to the Covid pandemic and the ultra-fast vaccine roll-out, a banking crisis could provide just the catalyst to make it happen.