developing the role of CBDC in monetary policy

I came across this very interesting post the other day. Essentially it analyses the demand for bank reserves at the central bank. In 1983 the collective reserve target for UK Clearing Banks reserves was £184 million, but it seems to have crept up a bit since then to between "£325 billion to £480 billion". Reserves are the highly liquid part of High Quality Liquid Assets (HQLA) which meet the Liquidity Coverage Ratio that needs to be maintained by all banks under the Basel rules as evidence that they have enough liquidity to meet their obligations as they fall due. The idea is that in a period of stress the bank has enough assets that it can mobilise (ie. sell or repo) without a massive discount in the price on the asset to fund an outflow of cash.

This links directly to the concept of stable coins and CBDC. In the past a bank may bolster its core liquidity by issuing regular tranches of Certificates of Deposit that are repayable on a fixed period but which are also bearer instruments that could be traded in the market (subject to rules that were published by the British Bankers Association). Since they were bearer instruments there were rules covering physical delivery and the security printing features that we embedded in the Certificates. However, after dematerialisation, banks instead relied on syndicated funding to cover foreign currency needs and the repo market to provide a layer of non callable funds to protect the balance sheet. In the Japanese market crash in 1991, it was shown foreign currency could quickly become unavailable in times of stress as bilateral credit lines were removed. In 2008 the market came to a standstill for both domestic and foreign borrowing as fear led to the closure of most borrowing markets. It was this "contagion" that necessitated the Central Banks and Treasuries to step in ultimately led to the huge tax payer support that resulted in some banks coming into public ownership.

In monetary policy the aim is either to increase balances in the private sector to create liquidity, or to reduce balances and thereby liquidity. This results in either more borrowing or less, and the margin creates greater or lesser demand based on the inflationary outlook. Quite obviously at the moment we are at a turning point where Central Banks are desperately trying to remove transactional balances from the system to bear down on inflation. CBDCs strike me as the ideal flexible instrument to replace these reserves. The CDBC is not interest-bearing, so the desire of a bank to hold CBDC would be limited by their opportunities to use reserves in their lending or trading books for other purposes. This directly relates to real economic activity, not financially incentivised activity as was in induced by Quantitative Easing. For a second point, designating CBDC as HQLA and including CDBC in General Repo would make them fungible.

To be continued...