|
|
Central banks have been considering the introduction of central bank digital currencies (CBDCs). The theoretical literature indicates that this may influence private banks’ lending activity and their profitability with implications for financial stability. To provide empirical evidence on this debate, we study the effects of the arrival of a new central bank issued currency on commercial banks in a historical setup. We use the opening of the Bank of Canada in 1935 as a natural experiment to provide evidence that banks mostly affected by the currency competition experienced lower profitability but did not decrease their lending compared to unaffected peers.
In recent years, there has been an increased interest from central banks around the globe in central bank digital currencies (CBDCs) issuance. In an increasingly digitalized world, central banks stand in front of a challenge to adapt to the new environment. At this stage, it is difficult to fully identify the advantages and disadvantages of CBDC, given that it may be implemented in several ways, see Bordo and Levin (2017), Mersch (2017) and Keister and Sanches (2023). However, first studies (see Mersch, 2017; BIS, 2018; Stevens, 2017; Mancini-Griffoli, Peria, Agur, Ari, Kiff, Popescu, and Rochon, 2018; Davoodalhosseini and Rivadeneyra, 2018) note that the business model of commercial banks may be affected by the introduction of CBDC, in particular the funding side of the banks (deposits) and their profitability.
Several theoretical papers (Andoflatto, 2021; Chiu et al., 2023; Whited et al., 2022; Williamson, 2021; Keister and Sanches, 2023) consider the effect of CBDC on private banks, studying the impact of new public money on profits, lending, interest rates prevailing in the private market. However, there is a lack of empirical evidence to validate these models, because, as pointed out in Andolfatto (2021), we have no available data to assess the impact of CBDC on commercial banks. First examples of active CBDC projects include quantitative restrictions so that the competition with commercial banking is limited (Söderberg et al., 2022). In situations like this, studying similar events from banking history may provide valuable and insightful factual assessment. In a recent paper (Grodecka-Messi and Zhang, 2023), we draw lessons from a historical experiment in which the central bank introduced a new medium of exchange in competition with the circulating private money. Our findings may shed some light on the impact of new public money (CBDC) issuance on banks’ business models and stability.
We turn our attention to the period when the competition of central and commercial banks over currency issuance played itself out at the cash level. In Canada, which lies at the center of our study, the central bank gained cash monopoly fairly late. Before that, numerous private banks were printing their own money, making it an important part of their funding (Söderberg, 2018). While it may perhaps not be obvious at first, there are many similarities between banknotes and CBDCs. Both central bank cash and CBDC are a form a central bank issued money that should be widely accessible and can be viewed as competition to the commercial banks’ funding sources (private banknotes in the past and deposit money today), see BIS (2018). As Engert and Fung (2017) note, both can be also subject of seigniorage revenue to the central bank. They both can serve as means of payment, unit of accounts and store of value, fulfilling the main functions of money, see Camera (2017).
Of course, some features of CBDC are different than those of cash, e.g. CBDC can be an answer to the zero-lower bound problem, while cash is subject to it. CBDCs are launched in a world with multiple payment technologies and institutions, while notes (and coins) dominated the currency market in the past. The technological challenges of CBDC are clearly different than those of cash. Nonetheless, if CBDC does not pay interest, it is quite similar to cash in its nature, which allows us to make the historical analogy. Our research delivers insights on how central bank’s note monopoly affected commercial banks, focusing on the potential cost side of the implementation of a new form of non-interest bearing central banking money.
The historic event we studied is the establishment of the Bank of Canada and its money monopoly. In the 19th and the beginning of the 20th century, chartered Canadian banks issued the paper currency in Canada. The right to print money distinguished them from other financial intermediaries in Canada. The majority of the banknotes circulating in the public was issued by commercial banks, as Figure 1 depicts....
more at SUERF