Should the Fed issue a new central bank digital currency (CBDC)?
A recent “white paper” by Rep. Jim Himes (D-Conn.) says the answer is yes. It outlines the goals and characteristics of the new Fed digital dollar Himes, which is envisaged to be mandated in yet-to-be-enacted legislation.
Without discussing the merits of a new Fed CBDC, it’s important to understand that all of Himes’ goals can be achieved without a digital dollar. Insured depository institutions and state-licensed money transfer agents could create the tokenized dollar payment system envisioned in the white paper. Under this approach, the Fed does not need to issue a CBDC; its only additional responsibility is to oversee the new ledger-based payment system.
The Federal Reserve has issued a digital currency in the form of reserve balances held in the master accounts of banks in the Fed’s area. Reserve balances are backed by the full trust and credit of the U.S. government and are free of default risk. Only insured depository institutions and a limited number of specialized financial institutions can open a Fed master account and have reserve balances.
While only a few institutions can hold reserves at the Federal Reserve, any consumer or business can own digital currency in the form of a deposit at a depository institution. These deposits are backed by the full trust and credit of the U.S. government, up to $250,000 per account – the FDIC deposit insurance limit. In theory, deposits that exceed the insurance limit could be lost if the insured depository institution fails. However, in most cases, all deposits in the bankrupt institution are acquired by another bank without any loss to the depositor. In addition, depositors can expand explicit FDIC coverage by opening accounts with multiple banks directly or indirectly using deposit brokerage services.
The Himes white paper envisions the Federal Reserve issuing a new CBDC that is tokenized, held by the public, and used for retail transactions in lieu of cash. Tokenization means that CBDC dollars are transferred between accounts (aka wallets) using some type of distributed ledger system.
The document suggests that a Fed CBDC “should be deployed using a permissioned semi-distributed architecture… [that] Only authorized participants will be allowed to access the underlying payment database. Financial regulators will decide which institutions have access to the database. The document warns that these new digital dollars must be “structured in a way that preserves commercial bank maturity transitions and does not reduce the availability of credit.” “
Rep. Himes proposed a Fed CBDC as an intermediary, meaning depositors would open wallets at approved financial institutions. These institutions will manage the current client interface activities associated with the client accounts of the depository institutions. Approved institutions may include insured depository institutions and state-licensed money transfer agents, including licensed stablecoin issuers. Approved financial intermediaries will be responsible for enforcing all anti-money laundering and know-your-customer agreements currently applicable to bank accounts and money transfer agents. These intermediaries will manage the accounts and may compete to develop account services that attract customers’ Fed CBDC balances.
According to Himes’ paper, a clear benefit of a Fed-issued CBDC is that it “like traditional cash, is backed by the full trust and credit of the U.S. government, and will provide holders with a level of access that may not be available.” Security. Through privately issued stablecoins…” To mitigate the potential risk of a run on the banking system, the paper argues that there should be limits on the balances that can be held in Fed CBDC wallets to reduce the possibility that “CBDC may also be viewed by consumers” Sex acts as a safe haven in times of financial stress, leading to a countercyclical decline in bank deposits. The white paper also suggests that, similar to cash, CBDC wallets should not pay interest.
The characteristics and goals set out in the Himes white paper can be achieved without issuing a new Fed CBDC. If regulated depository institutions and remittance agents are encouraged to work with the Federal Reserve to develop the “permissioned semi-distributed ledger” payment processing system envisaged in the white paper, they could offer tokenized deposit accounts to retail customers and businesses, as they do Check Today account. These new tokenized dollars will be federally insured up to an FDIC limit of $250,000 if the wallet is held at an insured depository institution.
Under this alternative method of creating tokenized bank deposit accounts, unlike the issuance of a new Federal Reserve CBDC, the availability of bank credit would not risk disintermediation or negative impacts, as these balances are just a new type of bank deposit account, Rather than the balance being held by the Fed. Likewise, in times of crisis, banking system deposits do not flow into the Fed’s CBDC wallet because the Fed does not issue CBDC.
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Since the passage of Dodd-Frank, tokenized bank deposit accounts can pay interest just like checking accounts are allowed to pay interest, but if Congress prefers these deposits to mimic paper money, they don’t need to. Depository institutions and state licensed money transfer agents issuing these new accounts will comply with all existing federal and state safety and soundness regulations and anti-money laundering know-your-customer rules that they must comply with today. There is no need to revisit financial regulations, as these accounts are just like existing accounts, only they use a new type of payment system to clear and settle transactions.
It would be wrong to focus on issuing a Fed CBDC. Private sector financial systems—insured depository institutions and state-licensed money transfer agents—in partnership with the Federal Reserve system, can develop the payment infrastructure needed to transfer tokenized dollar balances to facilitate consumer and commercial transactions. The Fed should be encouraged to help the private sector develop this system, but it does not need to issue a tokenized digital currency that is transmitted through this system. Insured depository institutions and licensed money transfer agents can create and manage tokenized dollars in the wallets they serve, and the Federal Reserve can exercise oversight over this next-generation payments system.
Paul Kupiec is a senior fellow at the American Enterprise Institute, specializing in financial services issues.