Interbank market news scan: Incentivizing the market for a CBDC.

I am admittedly indifferent to the US government’s potential approval and the Federal Reserve’s deployment of central bank digital currency. Understandably, much concern has been raised by privacy advocates that a digital currency could be programmed to limit or expand the number of vendors or individuals with whom taxpayers could spend money. Gradually moving from paper currency to digital currency would put anonymity in transactions into obsolescence.

We can argue today that hardly anyone uses cash. Whether it’s a debit card, credit card, or EBT card, spending has long been via a plastic representation of digital cash. The difference being presented today is that the card once issued by a commercial bank could be issued by the U.S. central bank, the Federal Reserve.

Commercial banks will still have a role in a central bank digital currency world, likely as the digital wallet distributor, Central banks will take a more visible role as, under a central bank digital currency regime, a digital currency would be recorded as a liability on the Federal Reserve’s balance sheet versus a commercial bank’s balance sheet.

Officially, the Federal Reserve is still in the development phase of a digital currency. The perception is that a digital currency will be complementary to the current commercial bank model. If so, then what incentive could be offered to a bank customer that would get her to switch to the digital currency?

One incentive is the allowance of customers to enter their own version of a federal funds overnight market.

In the federal funds market, commercial banks buy and sell their excess reserves where the reserves have fallen below the requirement amount set by the Federal Reserve System. Commercial banks currently exchange these excess reserves at a rate between 4.75% and 5.00% in the interbank overnight market.

Why not amend the Federal Reserve Act so that depositors can create and enter their own overnight market where they authorize the exchange of funds at some rate agreed to by depositors? Rather than risk less than optimal participation in the digital currency system including the risk that black markets for US currency are created, the government and the Federal Reserve could consider such an incentive system.

Alton Drew

9 April 2023

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