Pub. 10 2022 Issue 2


Banks Are Worried About A CBDC. Not Nearly Worried Enough.

When it comes to the creation of a U.S. central bank digital currency, many bankers take comfort in the conventional wisdom that any such move — if it happens at all — will take years to come to fruition. With many technical hurdles to overcome, not to mention the massive challenge in passing legislation to authorize a CBDC, they believe time is on their side.

Indeed, a recent IntraFi survey found concerns raised by banking trade groups about a possible CBDC had not yet drifted down to most institutions. Only 13% of the more than 400 executives polled rated the creation of a CBDC as a subject of concern. In contrast, more than 40% of them were more worried by the Consumer Financial Protection Bureau’s crackdown on so-called “junk” fees or its pending rule to collect more data on small business loans.

This complacency is dangerous. While I understand concerns about both these CFPB initiatives, their importance pales in comparison to what the Federal Reserve Board is contemplating now. If bankers are not careful, they may find themselves on the losing end as they watch the Fed create an alternative to federally insured deposits. This would inevitably drain funding from community banks, impacting the availability of credit nationwide, and likely fuel further consolidation in the industry.

There may be other harmful impacts as well. The European Central Bank has estimated that if it implements its project to create a European CBDC, it will drain 12% to 20% of deposits out of the private-sector system, according to Randal Quarles, the former Fed vice chairman for banking supervision. Quarles warned that if that happened in the U.S., policymakers would inevitably seek to redirect some of those funds back to banks, and that would come with political strings attached.

“That’s going to have to be reintermediated somehow … unless we want a contraction in the economy,” he said on an episode of IntraFi’s Banking with Interest podcast. That “will come with strings. It will be directed to where the politicians would like it. It will be withheld from where the politicians don’t want it … All of it is unavoidable if you have a central bank digital currency that is even partially disintermediating the private sector banking system.”

“In future states where other major foreign currencies are issued in CBDC form, it is prudent to consider how the potential absence or presence of a U.S. central bank digital dollar could affect the use of the dollar in global payments”

To be sure, it is true that a CBDC is not yet ready for deployment. Speaking to the House Financial Services Committee last week, Fed Vice Chairman Lael Brainard said the development of a CBDC would take at least five years to develop after it has been authorized. She cited technical issues that must be sorted out, but used that as an argument for why
Congress should not debate the issue too long.

Some lawmakers also do not appear anxious for the Fed to move forward. Rep. Patrick McHenry, the top Republican on
the House Financial Services Committee, told Brainard that “no one has made a compelling case” for why a central bank digital currency is needed.

But banks must not take such comments as proof that Congress will not act. Despite some lawmakers’ misgivings, Brainard and supporters of a CBDC repeatedly have raised fears that the U.S. dollar will no longer be the world’s reserve currency unless it creates its own digital dollar.

“In future states where other major foreign currencies are issued in CBDC form, it is prudent to consider how the potential absence or presence of a U.S. central bank digital dollar could affect the use of the dollar in global payments,” Brainard said.

This is precisely the kind of argument liable to win over lawmakers from both political parties.

“It is hard for us to see Republicans standing in the way if the role of the dollar in global trade is put at risk because there is a digital Euro but not a digital dollar,” wrote Jaret Seiberg, an analyst with Cowen Washington Research Group, in a recent note to clients.

Quarles raised a similar fear, noting that “national security politicians, many of them conservative Republicans,” might
support a CBDC because of fears of what China and other countries are doing.

And although it may seem that lawmakers have a ways to go — and some reluctance — about pursuing a CBDC, history
has taught bankers that is no guarantee action won’t happen, often much quicker than expected. Time and again, crises
have pushed bills that the financial services industry thought would never pass quickly across the finish line. In August 2001, American Banker ran a story about how the prospects for the passage of an anti-money laundering bill were slim to none. By October, that bill was the law of the land. What happened to cause such a drastic turnaround? The Sept. 11 terrorist attacks.

A similar dynamic occurred not even a decade later when the creation of the CFPB went from a pie-in-the-sky proposal by a relatively obscure Harvard law professor to the agency opening its doors a few years later in 2011 (and that professor later being elected to the U.S. Senate).

While some may say these are exceptions, I would argue it has become increasingly the norm in passing controversial
legislation. Those bills often sit on the backburner, stuck until a crisis vaults them to the front and spurs enactment. It is easy to imagine a scenario in which the position of the U.S. dollar appears precarious or some foreign crisis fuels doubts about whether the dollar is the world’s reserve currency. How quickly do you think lawmakers will act if that appears in jeopardy?

For his part, Quarles appears confident a CBDC won’t happen. But that’s only because he is counting on the strong opposition of the banking industry. And while the banking trade groups have taken compelling positions against a CBDC, that will not be enough if those concerns do not drift down to individual bankers at the grassroots level.

To bankers, the advent of an CBDC can’t be treated like a C- or even B-level concern. They must recognize it for the existential threat it poses — and ensure Congress hears their objections loud and clear.