Digital Assets May Be Good for Households But Bad For Banks

Increased use of digital assets could help to improve the quality of life for society, but they also present challenges to the banking sector, the US Treasury said Wednesday.

Private digital assets, such as stablecoins issued by banks, as well as public central bank currencies, could harm financial stability, increasing the likelihood of sector-wide crises, according to a report published by the US Treasury Department’s Office of Financial Research (OFR).

Their proliferation could make it harder for banks to recapitalize following losses due to digital assets’ ability to depress spreads, meaning the difference between interest rates that banks charge for loans and the interest rates they pay to depositors.

The irony of the well-worn narrative is not lost on market observers, who witnessed a historic run on Silicon Valley Bank earlier this month, despite most of its issues stemming from poor risk management and not its exposure to the nascent asset class.

The OFR report sidesteps the contribution digital assets or CBDCs may make to bank runs and the disintermediation of bank deposits. The focus, instead, is on cases of systemic deleveraging and requisite financial fragility resulting from low levels of bank equity.

The adoption of digital assets can increase household welfare “significantly despite the decrease in financial stability,” the authors wrote — but only up to a point, after which financial instability can become harmful.

“The welfare-maximizing level of digital currency may be less than what would be provided by profit-maximizing issuers in a competitive market,” the report reads. It suggests regulation or other policy interventions may be necessary to square the interests of issuers with what’s best for society.

For instance, the authors caution, if digital assets move closer to a “perfect substitute” for deposits, their issuance is more likely to lead to welfare declines.

On average, digital currency issuance leads to an increase in asset prices and a decrease in their volatility, the report concludes.

In other words, the authors write, financial markets improve even as the financial sector suffers.

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