What Doesn’t Kill You Makes You Riskier: The Impacts of CBDC on Banking Stability

Abstract

Banks will find costly to hold onto its depositors when central bank digital currency (CBDC) is introduced. As baseline consumer benefit from using CBDC (denoted by ``$R$'') increases, more consumers will adopt CBDC despite a high deposit rate, downsizing the banks' balance sheets. Particularly, highly financially intelligent consumers will prefer new CBDC-based financial services, weakening market discipline in banking by the remaining depositors. To overcome the high borrowing cost, the banks take on excessive risks when $R$ has intermediate values. Moreover, the aggregate surplus from banking is $U$-shaped in $R$ when the banking instability caused by CBDC gets underway.