The Strategist

Bundesbank: digital currencies are dangerous to banks

06/15/2017 - 15:19

Head of the Central Bank of Germany Jens Weidmann said that widespread of digital currencies poses a threat to the banking system, and the authorities need to think how to "reduce citizens' interest in digital currencies".

In his speech at Frontiers in Central Banking - Past, Present and Future forum in Frankfurt am Main, President of the Bundesbank told that new technologies may harm the banking sector.

Jens Weidmann noted that if citizens can instantly transfer their funds to any official digital currency, this will significantly increase the risk of massive withdrawal of deposits from banks during crisis periods.

"The main challenge is likely to be deep changes caused by the proliferation of digital technology. Digitalization will create new kinds of finance-related intermediation. And although this may be a positive factor for the economy, financial institutions may face issues that concern the conduct of monetary policy under changed conditions.

A number of experts suggest that digital currencies created on a private basis can completely replace traditional currencies. However, more careful economic analysis shows that such a development of events is unlikely. Money is subject to a significant and ramified influence of external factors that digital currencies are unlikely to overcome. I'm also pretty sure that central banks can provide better price stability than any unchanged monetary rule or algorithm.

And yet, despite the fact that alternative currencies are still a peripheral phenomenon, a number of experts are already calling on central banks to think about adopting new technologies and creating their own digital money. This may result in the fact that non-financial corporations and even ordinary citizens would get access to central bank assets in a digital balance, which, contrary to cash, does not require significant storage costs.

However, what may seem intriguing in terms of technology also entails disturbing questions about the nature of the finances and our economy as a whole. If we allow the population to hold assets of any banking institution, their liquid assets will become more secure, since it is impossible for the central bank to go bankrupt. This aspect can acquire special significance during a crisis, when citizens have a serious incentive to transfer their bank deposits into a reliable alternative currency by just touching a button. However, what is good for depositors who want security for their assets, can become disastrous for financiers, as this means that the massive withdrawal of funds by depositors of banks can happen even faster than now.

Withdrawing deposits from banks also deprives them of the ability to convert short-term deposits into longer-term loans. Thus, new technologies are renewing the old economic dispute: does the transformation improve the financial sustainability, or must banks be prohibited from creating liquidity?

My point of view is that central banks should turn existing payment systems into more efficient and faster one - the subject of instant payments has become fashionable today as never before. I'm pretty sure that this would reduce the interest to digital currencies". 

It should be noted that the statement of the Bundesbank’s Head contains a number of contradictory points. In particular, Jens Weidmann stated that "the central bank cannot go bankrup"t, certainly bearing in mind that a central bank that has the ability to print money cannot go bankrupt.

At the current stage of the European financial system’s development, this option is no longer possessed either by the Bundesbank (the German Central Bank), the Bank of France, or any other national bank representing a country belonging to the euro area.

Another ambiguous point in the statement is that the arguments about the relationship of money, depositors and banks only takes into account the extent to which investors and their money are needed by banks, and not vice versa.

Until now, the development of digital technologies and currencies, which are not subject to the control of the Central Bank, has heavily relied on what is beneficial to individuals, rather than to financial authorities or large banks.

At the same time, the world’s banks, both private and public, keep trying to catch up with the development of digital currencies. Therefore, it is quite likely that representatives of the financial establishment need to think not about "how to reduce the population's interest in digital currencies", but rather about how to retain at least some of the citizens' trust in the services of the traditional banking sector - including by controlling potential fraud and excessive speculative activity of banks, whose actions were the main cause of the global financial crisis in 2008.