Will an Interest-bearing CBDC Shape the Lending Industry?

According to the model, the white area of Panel A shows an increase in deposits and a shrinkage in physical cash if we move along the x-axis — when the CBDC is more cash-like (θ closer to 1). Hence, we conclude that a rise in deposit rates leads to an increase in the amount of CBDC holders (represented by the upward black line). However, when the CBDC becomes even more cash-like — θ getting closer to 1 — it reaches a threshold where network externalities lead to a cashless equilibrium. The switch of more users becoming CBDC holders makes cash insignificant, making it disappear. As θ moves closer to 1, returns on deposits holdings exceed those of holding a CBDC and, therefore, diminishes the number of CBDC users.

On the contrary, Panel B illustrates a negative correlation between CBDC-rate and cash holdings; physical cash shrinks as rcbdc rises. Deposits decrease too. High rcbdc leads to the actual disappearance of cash.

Nonetheless, note the actual naiveté of having an interest-bearing CBDC which can, indeed, open many doors to policy-making: Central Banks could change the CBDC-rate to avoid fading cash, thereby, nudging households to use more cash or deposits. It is at this stage when an interest-bearing CBDC comes into play — more about it below.

An Interest-bearing CBDC: Central Bank’s Underlying Diamond?

The introduction of a CBDC that competes with bank deposits could lead banks to increase deposit rates, making them more attractive. Considering that banks engage in Cournot competition in the deposit market and face a perfectly competitive lending market (that’s a far-reaching and bold assumption which allows the above-mentioned model to work), a CBDC would also expand bank intermediation provided that the interest rate on the CBDC is set at a range between 0.05% and 1.79% (Chiu J. et al., 2020).

Hence, in a sense, the CBDC would force banks to raise the deposit rate, generally kept low in imperfectively competitive deposit markets. Higher deposit rates would attract more deposits, lower lending rates and expand lending. As already said, this a marvellous feature of an interest-bearing CBDC; acting as an outside force, it pushes non-competitive banks to match the CBDC rate.

Another strong finding of this model is that the interest-bearing CBDC keeps cash alive, by changes in the interest rate.

This relevance is observed in Figure IV where, as indicated in the RHS of the diagram, when network effects bind and combine with a negative rcbdc , adverse network effects on cash are mitigated and makes CBDCs less interesting and cash more demanding.

Additionally, being the rate on bank deposits, instead of the policy rate (a.k.a. base rate), that which determines the level of borrowing costs for firms and households, an interest-bearing CBDC could enhance competition in the deposit market, foster investment with lenient lending policies and bring back economic stability, particularly in hyper-inflationary jurisdictions like Zimbabwe and Venezuela, restoring consumers’ confidence in the home currency.

Since interest-bearing CBDCs turn out to have more policy relevance and have huge potential to change the lending industry (as we have discussed throughout this article), considering that the major literature on CBDC design concerns non-interest-bearing CBDCs, further qualitative research on the matter is expected to upsurge in the near future and would help to better assess the feasibility of this new payment instrument, especially its design part.

Source: https://medium.com/coinmonks/will-an-interest-bearing-cbdc-shape-the-lending-industry-ac4e9e441358?source=rss——-8—————–cryptocurrency