ECB Designs Two-Tier Model of a CBDC

January 6, 2020, by Marko Vidrih on The Capital

The European Central Bank is preparing to introduce a central bank digital currency (CBDC). However, using digital currency as an investment could endanger the banking system. To prevent the banks from losing their function as lenders, a new draft by the ECB proposes a two-stage interest rate model of a CBDC.

After the ECB announced the proof of concept of a central bank digital currency (CBDC) a few weeks ago, the concept of digital currency is gradually taking shape. In a current paper, Ulrich Bindseil, Director General for Market Infrastructures and Payment Transactions of the ECB discusses the advantages and risks of a CBDC for the European currency area and develops the model of a two-stage CBDC system.

According to Bindseil, a CBDC must ensure that commercial banks maintain their current role as lenders to businesses and consumers. If consumers hold assets in CBDC, there is a risk that banks will not have enough deposits to lend money. This could result in the disintermediation of the banks, i.e. the elimination of financial intermediaries in the financial system.

Binding explains that central bankers, in particular, warn of structural or cyclical disintermediation of deposit collectors, ie banks, which could be caused by the CBDC. It is therefore vital to manage the issuance of CBDC in such a way that it is efficient for retail payments, without necessarily jeopardizing the monetary system, by making a CBDC an important form of value retention.

To prevent a CBDC as a pure store of value, a CBDC must primarily be designed for use in retail payments. A two-tier model is therefore intended to counter the risk posed by the shifting of commercial bank deposits to CBDC.

The two-tier CBDC system contains a general CBDC with attractive interest rates for payment transactions. The other type corresponds to an account-linked CBDC with low-interest rates for larger amounts. This would strengthen the function of a CBDC for payments and reduce the incentive to invest.

The paper proposes a euro area system of financial accounts that illustrates the mechanisms and effects of the CBDC and enables the effects on payments to be presented.

With the two-tier interest rate system, the lower tier applies to payments and the second tier applies to the retention of value. In the latter case, the interest offered would be relatively unattractive. This would prevent a CBDC as an investment and stabilize the function of the banks as donors, says Bindseil.

Author: Marko Vidrih

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