A central bank digital currency in a heterogeneous monetary union: Managing the effects on the bank lending channel

Abstract

A major obstacle for the implementation of a general-purpose central bank digital currency (CBDC) is the risk of bank disintermediation, potentially jeopardizing financial stability and the bank lending channel of monetary transmission. By adapting the theoretical framework of Dutkowsky and VanHoose (2018b, 2020) to the euro area, this study investigates and clarifies the conditions under which a digital euro could be introduced on a large scale without leading to bank disintermediation or a credit crunch. First, the central bank would require proper mechanisms to manage the volume and the user cost of CBDC in circulation. Second, the central bank should continue to facilitate access to its long-term lending facilities, to provide banks with a funding source alternative to client deposits at an equivalent cost. Depending on its design, a digital euro could improve bank profitability and competitiveness by absorbing large amounts of idle (and expensive) excess reserves without penalizing lending, while incentivizing bank digitalization.