Implications of central bank digital currency for financial stability: Evidence from the global banking sector

Abstract

This study analyses the implications of central bank digital currency (CBDC) for financial stability, specifically in the banking sector. Drawing on an international database on CBDC adoption, data on 1176 banks operating in 86 countries from 2010 to 2021 were used to construct a time-varying CBDC adoption index. Our key results suggest that the adoption of CBDC contributes to financial stability. Furthermore, bank size, capitalization, operational strategy, deposit funding and domestic investment also contribute positively while loan loss reserve negatively affects bank stability. These findings are robust to a comprehensive set of tests. We further find that CBDC helps to reduce leverage and asset risks. Other evidence suggests that the adoption of CBDC can be associated with expanded lending, increased asset quality and reduced loan loss reserves. However, the impact of CBDC is only pronounced for banks of reasonable size but not for smaller banks. Moreover, CBDC adoption appears to have a more positive impact in emerging economies than in advanced economies. Finally, retail CBDC is found to promote stability, whereas wholesale CBDC hampers it. Overall, our findings have profound implications for the adoption of CBDCs and their implications for financial stability.