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---

### Glossary
- AAA: Triple-A
- ATM: Automated Teller Machine
- BCB: Central Bank of Brazil
- CBDC: Central Bank Digital Currency
- CBs: Central Banks
- CiC: Currency in Circulation
- ECB: European Central Bank
- FD: Financial Dollarization
- FX: Foreign Exchange
- GDP: Gross Domestic Product
- GFC: Global Financial Crisis
- IT: Inflation Targeting
- LOLR: Lender of Last Resort
- M0: Monetary (or Money) Base
- NPCI: National Payments Corporation of India
- NPV: Net Present Value
- OMO: Open Market Operations
- PSP: Payment Service Provider
- QE: Quantitative Easing
- RBI: Reserve Bank of India
- RD: Real Dollarization
- SMEs: Small and Medium-sized Enterprises
- UPI: United Payments Interface
- USDC: USD Coin

### Introduction — context and purpose
- Digital money is characterized as the next step in the technological advancement of payment systems, prompting central banks to review monetary policy and operations.
- The paper studies potential implications of digital money on central banks balance sheet.
- Historical milestones referenced:
  - Federal Reserve System created in 1913.
  - Collapse of Bretton Woods exchange rate peg system in 1971.
  - High inflation episode during the 1970s and early 1980s influenced a shift in monetary frameworks.
  - Quote (Gerald Bouey, 1983): “Central banks did not abandon monetary targeting; it was the other way around: money demand left central banks.”
- Paper structure overview:
  - Section II: bi-monetary (partially dollarized) economies.
  - Section III: central bank balance sheet and monetary policy under digital money, including CBDC issuance.
  - Section IV: implementation costs and cyber-related risks (wholesale vs retail).
  - Section V: six simulations of banking loans, money, and central bank balance sheet changes for different substitution types (e.g., stablecoins, MNOs, CBDC).
  - Section VI: forward-looking suggestions.
- Complementary references cited in the text: IMF (2021); IMF (2020).

### Lessons from Bi‑Monetary Systems — classification and consequences
- Four country types by dollarization:
  - Issuer of International Currency (Type A)
  - Open Economy under Dominant Currency Paradigm (Type B)
  - Partially Dollarized Economy (Type C)
  - Highly Dollarized Economy (Type D)
- Key functional distinctions across types: unit of account, means of payment, store of value.
- Characteristics and implications:
  - Financial dollarization (FD) is asset substitution driven by poor performance of local currency; local currency used for payments while FX used as saving/store of value.
  - Real dollarization (RD) occurs under extreme inflation (examples cited: Venezuela, Zimbabwe) with FX used as means of payment and store of value.
  - Hysteresis: reversal of entrenched bi-monetary systems is difficult even after initial triggers subside.
  - FD and RD impair the exchange rate’s role as shock absorber; RD implies high pass-through from depreciation to inflation; FD creates currency mismatches and liquidity risks.
- Stablecoins implications:
  - Rapid stablecoin growth may induce financial disintermediation (Kahn and Singh, 2021).
  - Stablecoins backed by central bank reserves allow money supply control with the central bank; backing by anything other than central bank reserves dilutes that control.
  - For issuers of international currency, higher demand for bonds to back stablecoins might result in larger capital markets and smaller banking systems.
  - Expansion of stablecoins linked to an international currency may increase dollarization or euroization, potentially inducing capital outflows.
- Policy‑relevant observation:
  - Risk of higher dollarization from dollar‑denominated stablecoins is larger in countries with high inflation, capital control measures, and/or restrictions on foreign currency accounts.

### Monetary Policy and Central Banks Balance Sheet — regime dependence and implications
- Balance sheet expansion context:
  - Central banks in developed economies expanded balance sheets after the Global Financial Crisis (GFC); some developing‑economy central banks also expanded balance sheets before resorting to international reserves and other operations.
- Regime distinctions:
  - Under monetary dominance, the central bank controls its balance sheet within its legal mandate; fiscal authority accommodates central bank profit/loss outcomes to keep public finances sustainable.
  - Reference to Sargent (1981): the net present value (NPV) of primary fiscal surplus plus NPV of seigniorage must equal public debt.
  - Under fiscal dominance, digital money that reduces seigniorage may prompt central banks to raise inflation tax or prevent financial innovations; monetary dominance (central bank autonomy) is preferred for achieving price stability (Leeper, 1991).
- Monetary policy transmission risks from digital money:
  - Interest rate and credit channels may weaken when:
    - (i) a Fintech issues stablecoins backed by treasury bonds; and
    - (ii) bank deposits are substituted by stablecoins in foreign currency.
  - Common outcome in these cases is a reduction in banking credit.
  - Conversely, substitution of CiC for private digital money that is deposited in commercial banks can expand banking credit.
- Policy guidance elements:
  - Maintain level playing field: “same regulation for the same type of financial activity or risk” to avoid regulatory arbitrage.
  - Encourage competitive environment for tech firms and leverage positive externalities (e.g., interoperability) while the state intervenes only when private sector under‑provides such externalities.
  - If seigniorage is not a constraint, payment system development should prioritize efficiency improvements.

### Payment Systems and Seigniorage — practical considerations
- Regulatory stance:
  - Regulators should encourage competition and innovation while ensuring comparable regulation across similar activities.
  - Interoperability and positive externalities should be promoted; state intervention only when necessary.
- Financial stability considerations:
  - FD-related financial instability responses may include central bank FX reserve buildup and associated regulation.
  - Expanded use of stablecoins or retail CBDC denominated in an international currency could have similar impacts to stablecoins backed by international assets.
  - Current likelihood of Fed or ECB issuing a retail international CBDC in the near future is noted as unclear.

### IV. Base Money Issues: M0 or Not
- Any CBDC would coexist with other forms of money (so not an exclusively M0 world).
- Possible states:
  - Traditional or bank tokenized deposits (M1) and some balances as CBDC (M0).
  - Bank holds all the M0 (like they do with reserves today) and uses that to offer tokenized deposits (M1).
- Value added of a CBDC may lie in establishing a token platform enabling new technologies not easily done in traditional systems.
- If basic features of CiC hold (non‑interest bearing, no caps, and complete privacy), then CBDC is digital CiC.
- RBI quote (July 2021, Deputy Governor T. Rabi Sankar): “To sum up, CBDC is the same as currency issued by a central bank but takes a different form than paper (or polymer). It is sovereign currency in an electronic form and it would appear as liability (currency in circulation) on a central bank’s balance sheet. The underlying technology, form and use of a CBDC can be moulded for specific requirements. CBDCs should be exchangeable at par with cash.”
- If CBDC deviates from CiC (e.g., interest bearing and/or capped), then it is a different instrument (a policy tool) targeting a new objective. Illustration: if Eurozone’s caps CBDC for retail at €1 trillion, with the underlying assumption that caps will not be binding as average retail transactions are around €1 trillion.
- Digital money velocity (instantaneous payment) will be faster than CiC. Thus, a mix of CiC and CBDC in time t+1 may be less than CiC in time t=0; base money may decline; and then so will seigniorage.
- Costs from cyber‑risk:
  - If quasi‑CBDC/stablecoins issuance is outside the central bank, ex‑ante large costs “C” (i.e., systemically important) from cyber‑risk will be picked up by the regulator due to financial stability and too‑big‑to‑fail logic—likely absorbed by the central bank (or ministry of finance/fiscal authority), irrespective of issuer.
  - If costs are small “c” (e.g., retail CBDC issuance) then private vendors (PSPs), banks/nonbanks/Fintechs may pick up cost c.
  - Cyber risk and associated costs much higher than counterfeit paper currency which in literature is not more than 0.01 percent of currency issued.
  - In the US, Fed is required by law to do full cost recovery for all payments services. In Euroland, the ECB does full cost recovery minus a "public good" adjustment.

### V. Monetary Aggregates and Bank Credit Under Digital Money — overview
- Starting framework: central bank with a policy rate as operational target.
- Six cases to study (types of money substitution):
  - (i) Bank deposits by stablecoins or e‑money (assets outside the banking system) backed by banking deposits.
  - (ii) Bank deposits by stablecoins or e‑money (assets outside the banking system) backed by treasury bonds or similar assets (i.e., good collateral).
  - (iii) Bank deposits by dollar‑denominated stablecoins in a partially dollarized economy.
  - (iv) CiC by e‑money.
  - (v) CiC by CBDC.
  - (vi) Bank deposits by CBDC (similar to reserves at central bank).

### Case (i): Substitution of Bank Deposits by Stablecoins or E‑money backed by Banking Deposits
- Initial conditions (period t=0):
  - Reserve requirement (RR) of 5 percent on deposits with zero excess reserves.
  - To diversify credit and liquidity risks commercial banks hold 10 percent of deposits at current interest rates at time t=0.
  - Preference for CiC (CiC/Money) is 25 percent.
  - M1 = 4000, M0 = 1150, deposits = 3000.
- Central bank’s balance sheet at time t=0 — Commercial Bank (t=0):
  - Assets: 2550 Commercial Loans; 300 Treasury Bonds; 150 Reserves at Central Bank
  - Liabilities: 3000 Individuals’ Demand Deposits
- Central Bank (t=0):
  - Assets: 1150 Interest Bearing Financial Assets
  - Liabilities: 1000 CiC; 150 Reserves
- Period t=1: a mobile operator phone company provides e‑money and, by regulation (or its own decision), the float is deposited at a commercial bank. E‑money improves payments through banks, so no substitution with CiC at the central bank; only redistribution of banking deposits.
- Deposit break‑up at t=1: 2800 individual demand deposits and 200 mobile phone company deposits (from original 3000).
- Mobile Operator Phone Company (t=1):
  - Assets: 100 Infrastructures; 200 Deposits with Commercial Banks
  - Liabilities: 100 Capital; 200 Customer Accounts
- Commercial Bank (t=1):
  - Assets: 2550 Commercial Loans; 300 Treasury Bonds; 150 Reserves at Central Bank
  - Liabilities: 2800 Individuals’ Demand Deposits; 200 Phone Company Demand Deposits
- Outcome: redistribution of demand deposits only; no change in asset side; central bank balance sheet does not change at all.

### Case (ii): Substitution of Bank Deposits by Stablecoins or E‑money Backed by Treasury Bonds (good collateral)
- Starting point: period t=0 as in Case (i).
- Fintech Issuer of a Stablecoin (t=1a):
  - Assets: 100 Infrastructures; 200 Treasury Bond
  - Liabilities: 100 Capital; 200 Stablecoins
- Financial disintermediation dynamics:
  - Fintech increases demand for treasury bonds; commercial banks face withdrawal of 200.
  - Demand for bank reserves falls by 10 (i.e., 5 percent of 200).
  - Commercial banks likely sell bonds to Fintech, affecting Treasury bond yields; they avoid fire sales of commercial loans.
  - Central bank would probably sell treasury bonds to accommodate lower banking reserves, leading to moderate reduction of seigniorage.
- Commercial Bank (t=1a):
  - Assets: 2550 Commercial Loans; 110 Treasury Bonds; 140 Reserves at Central Bank
  - Liabilities: 2800 Individuals’ Demand Deposits
- Central Bank (t=1a):
  - Assets: 1140 Interest Bearing Financial Assets
  - Liabilities: 1000 CiC; 140 reserves
- Outcome: base money declines from 1150 to 1140 and traditional money (M1) declines from 4000 to [text truncated in source].

### Stablecoins, money definition, and velocity
- If stablecoins are included in the definition of broad money, there is no change, and the figure is 4000.
- Given the nature of the stablecoins, it is likely to have relative more use as a means of payment and less as store of value compared with the average banking demand deposits (in particular time deposits) and therefore the implicit velocity from the quantitative money equation will be larger.
- Efficient liquidity management for Fintech issuers will depend on the depth and liquidity of the treasury bond market (including repo market).
- In the example, stablecoins are outside the regulatory (and counterparty) perimeter of the central bank; under the current framework, central banks run OMO with depository institutions (mainly banks). An open question: if authorized stablecoins and PSP should have access to open current accounts at the central bank.

### Example dynamics: commercial bank balance sheets and credit impact
- At period t=2a (after loans start to be repaid), assumed commercial bank balance sheet:
  - Assets: 2380 Commercial Loans; 280 Treasury Bonds; 140 Reserves at Central Bank
  - Liabilities: 2800 Individuals’ Demand Deposits
- Banking credit to the private sector falls 4.8 percent.
- Large companies may substitute reduced commercial loans by issuing corporate debt or external bank lending; SMEs often cannot.
- As banking credit shrinks, the transmission mechanism of monetary policy weakens (credit will be lower).

### Case (iii): Substitution of bank deposits by stablecoins in foreign currency (partially dollarized economy)
- Contextual assumptions:
  - Allowed to open dollar deposits in period t=0.
  - Regulation establishes a reserve requirement or liquidity ratio of 25 percent for those deposits.
- Balance sheets at t=0 (selected lines):
  - Commercial Bank (t=0) Assets: 2380 Commercial Loans in Domestic Currency; 280 Treasury Bonds in Domestic Currency; 140 Reserves at Central Bank; 150 Commercial Loans in Foreign Currency; 50 U.S. Treasury Bond
  - Liabilities: 2800 Individuals’ Demand Deposits in Local Currency; 200 Individuals’ Demand Deposits in Foreign Currency
  - Central Bank (t=0) Assets: 1140 Interest Bearing Financial Assets; 140 Reserves. Liabilities: 1000 CiC.
- Fintech issuer when dollar deposits are allowed (t=1):
  - Assets: 100 Infrastructures; 100 U.S. Treasury Bond
  - Liabilities: 100 Capital; 100 Stablecoins in Dollar
- Commercial Bank (t=1) (selected lines):
  - Liabilities: 100 Individuals’ Demand Deposits in Foreign Currency; 75 External Borrowing or, CB liquidity to support foreign currency liquidity (e.g., FX swap line)
  - Assets: 25 U.S. Treasury Bond; 150 Commercial Loans in Foreign Currency; 140 Reserves at Central Bank
- Central Bank (t=1) Assets include 1140 Interest Bearing Financial Assets and CB Liquidity Support in Foreign Currency to Commercial Banks; Liabilities: 1000 CiC; 140 Reserves.
- Capital outflows create dollar liquidity shortages; banks borrow internationally or receive CB foreign‑currency liquidity support.
- Period t=2: banks reshuffle portfolios, reducing need for external borrowing or CB support; example balances:
  - Commercial Bank (t=2) Assets: 75 Commercial Loans in Foreign Currency; 25 U.S. Treasury Bond; Liabilities: 100 Individuals’ Demand Deposits in Foreign Currency; Reserves 140
  - Central Bank (t=2) Assets: 1140 Interest Bearing Financial Assets; Liabilities: 1000 CiC; 140 Reserves
- The example shows the impact on banking credit for partial dollarization is lower because local deposits in foreign currency allow banking lending in the same currency.

### Case (iv): Substitution of CiC by e‑money
- Observed trend: declining CiC before the pandemic; digital payment tools likely to continue driving decline as world returns to a “new” normal (Kahn et al., 2022).
- Example at t=1b:
  - Commercial Bank (t=1b) Assets: 2720 Commercial Loans; 320 Treasury Bonds; 160 Reserves at Central Bank. Liabilities: 3000 Individuals’ Demand Deposits; 200 Phone Company Demand Deposits.
  - Central Bank (t=1b) Assets: 960 Interest Bearing Financial Assets; Liabilities: 800 CiC; 160 Reserves.
- Effects:
  - Substitution of CiC by e‑money reduces preference for currency, increasing banking multiplier and lowering money base (1150 to 960) while keeping total Money constant at 4000.
  - CiC as a fraction of M1 is 20 percent now.
  - Supply of credit to private sector increases and seigniorage falls.

### Case (v): Substitution of CiC by CBDC
- When CBDC replaces CiC, only composition of base money changes in period t=1c; no impact on transmission mechanism of monetary policy; improved payment-system efficiency; no change in seigniorage.
- Digital money velocity is higher (Kahn et al., 2022). CiC (t1)+ CBDC (t1) may/may not be less than CiC(t0), so seigniorage from base money may decline.
- Monetary liquidity management implication: central banks should include daily movements of CBDC demand as a new autonomous factor to estimate OMO magnitudes.
- Central Bank (t=1c) Assets/Liabilities:
  - Assets: 1150 Interest Bearing Financial Assets
  - Liabilities: 800 CiC; 200 CBDC; 150 Reserves

### Case (vi): Substitution of bank deposits by CBDC (financial disintermediation risk)
- If CBDC replaces demand deposits and its services exceed private banking services, central bank balance sheet increases (in example from 1150 to 1340) and financial disintermediation can occur. This scenario has a low probability per central bank survey (BIS, 2022).
- Period t=1d (commercial banks cannot immediately reduce stock of credit):
  - Commercial Bank (t=1d) Assets: 2550 Commercial Loans; 110 Treasury Bonds; 140 Reserves at Central Bank. Liabilities: 2800 Individuals’ Demand Deposits.
  - Central Bank (t=1d) Assets: 1340 Interest Bearing Financial Assets. Liabilities: 1000 CiC; 200 CBDC; 140 Reserves.
- Banks sell treasury bonds to meet liquidity; central bank may purchase treasury bonds to accommodate higher base money demand.
- Extreme case: if stock of treasury bonds is insufficient, liquidity shortage may raise interbank rates well above policy rate unless central bank extends collateral for operations.
- Period t=2d: commercial banks reduce commercial loans from 2550 to 2380 to match deposits, weakening the interest rate and credit channels of monetary policy.
  - Commercial Bank (t=2d) Assets: 2380 Commercial Loans; 280 Treasury Bonds; 140 Reserves at Central Bank. Liabilities: 2800 Individuals’ Demand Deposits.

### Conclusions and policy implications
- Digital money will affect banking intermediation, external capital flows, and central bank balance sheets.
- Under fiscal dominance with reduced seigniorage, central banks may take actions to mitigate fiscal pressures; under monetary dominance, payment‑system development should focus on efficiency without jeopardizing monetary policy transmission.
- Depending on substitution type between traditional money and digital money:
  - There could be banking disintermediation as deposits move away from commercial banks.
  - Stablecoins in foreign currency may increase international financial integration; developing economies face new challenges regarding capital flows.
  - Operational aspects of digital money and CBDC impacts on disintermediation are nascent; using an interest rate on CBDC may be preferable only in extraordinary cases.
- Monetary policy perspective: interest rate and credit channels may weaken when:
  - Fintech issues stablecoins backed by treasury bonds,
  - Bank deposits are substituted by CBDC,
  - Bank deposits are substituted by stablecoins in foreign currency (possible in developing economies).
- Conversely, when CiC is substituted by private digital money that is deposited in commercial banks, banking credit may expand.

*Digital Money and Central Banks Balance Sheets — Working Paper No. WP/2022/206*

### References .............................................................................................................

### wpiea2022206-print-pdf - References .............................................................................................................

### Glossary
- AAA: Triple-A
- ATM: Automated Teller Machine
- BCB: Central Bank of Brazil
- CBDC: Central Bank Digital Currency
- CBs: Central Banks
- CiC: Currency in Circulation
- ECB: European Central Bank
- FD: Financial Dollarization
- FX: Foreign Exchange
- GDP: Gross Domestic Product
- GFC: Global Financial Crisis
- IT: Inflation Targeting
- LOLR: Lender of Last Resort
- M0: Monetary (or Money) Base
- NPCI: National Payments Corporation of India
- NPV: Net Present Value
- OMO: Open Market Operations
- PSP: Payment Service Provider
- QE: Quantitative Easing
- RBI: Reserve Bank of India
- RD: Real Dollarization
- SMEs: Small and Medium-sized Enterprises
- UPI: United Payments Interface
- USDC: USD Coin

### Introduction — context and purpose
- Digital money is characterized as the next step in the technological advancement of payment systems, prompting central banks to review monetary policy and operations.
- The paper studies potential implications of digital money on central banks balance sheet.
- Historical milestones and their dates referenced:
  - Federal Reserve System created in 1913 as a response to crisis and need for LOLR.
  - Collapse of the Bretton Woods exchange rate peg system in 1971.
  - High inflation episode during the 1970s and early 1980s influenced a shift in monetary frameworks.
  - Quote attributed to Gerald Bouey (1983): “Central banks did not abandon monetary targeting; it was the other way around: money demand left central banks.”
- Paper structure overview:
  - Section II: bi-monetary (partially dollarized) economies.
  - Section III: central bank balance sheet and monetary policy under digital money, including CBDC issuance.
  - Section IV: implementation costs and cyber-related risks (wholesale vs retail).
  - Section V: six simulations of banking loans, money, and central bank balance sheet changes for different substitution types (e.g., stablecoins, MNOs, CBDC).
  - Section VI: forward-looking suggestions.
- Complementary references cited in the text: IMF (2021); IMF (2020).

### Lessons from Bi-Monetary Systems — classification and consequences
- Four country types by dollarization (Table 1):
  - Issuer of International Currency (Type A)
  - Open Economy under Dominant Currency Paradigm (Type B)
  - Partially Dollarized Economy (Type C)
  - Highly Dollarized Economy (Type D)
- Key functional distinctions across types: unit of account, means of payment, store of value.
- Characteristics and implications:
  - Financial dollarization (FD) is asset substitution driven by poor performance of local currency; local currency used for payments while FX used as saving/store of value.
  - Real dollarization (RD) occurs under extreme inflation (examples cited: Venezuela, Zimbabwe) with FX used as means of payment and store of value (Table 1, Type D).
  - Hysteresis: once a bi-monetary system is entrenched, reversal is difficult even after initial triggers (e.g., high inflation) subside.
  - FD and RD impair the exchange rate’s role as shock absorber; RD implies high pass-through from depreciation to inflation; FD creates currency mismatches and liquidity risks.
- Stablecoins and implications:
  - Stablecoins have significant implications for monetary policy design and liquidity management; rapid stablecoin growth may induce financial disintermediation (Kahn and Singh, 2021).
  - Stablecoins backed by central bank reserves allow money supply control with the central bank; backing by anything other than central bank reserves dilutes that control.
  - For issuers of international currency, higher demand for bonds to back stablecoins might result in larger capital markets and smaller banking systems.
  - In other countries, expansion of stablecoins linked to an international currency may increase dollarization or euroization, potentially inducing capital outflows.
- Policy-relevant observation:
  - Risk of higher dollarization from dollar-denominated stablecoins is larger in countries with high inflation, capital control measures, and/or restrictions on foreign currency accounts.

### Monetary Policy and Central Banks Balance Sheet — regime dependence and implications
- Balance sheet expansion context:
  - Central banks in developed economies expanded balance sheets after the Global Financial Crisis (GFC); some developing-economy central banks also expanded balance sheets before resorting to international reserves and other operations.
- Regime distinctions:
  - Under monetary dominance, the central bank has control of its balance sheet within its legal mandate (price stability or dual mandates). Fiscal authority accommodates central bank profit/loss outcomes to keep public finances sustainable.
  - Reference to Sargent (1981): the net present value (NPV) of primary fiscal surplus plus NPV of seigniorage must equal public debt (equation presented in original text).
  - Under fiscal dominance, digital money that reduces seigniorage may prompt central banks to raise inflation tax or prevent financial innovations; monetary dominance (central bank autonomy) is preferred for achieving price stability (Leeper, 1991).
- Monetary policy transmission risks from digital money:
  - Interest rate and credit channels may weaken when:
    - (i) a Fintech issues stablecoins backed by treasury bonds; and
    - (ii) bank deposits are substituted by stablecoins in foreign currency.
  - Common outcome in these cases is a reduction in banking credit.
  - Conversely, substitution of CiC for private digital money that is deposited in commercial banks can expand banking credit.
- Policy guidance elements:
  - Maintain level playing field: “same regulation for the same type of financial activity or risk” to avoid regulatory arbitrage.
  - Encourage competitive environment for tech firms and leverage positive externalities (e.g., interoperability) while the state steps in only when private sector under-provides such externalities.
  - If seigniorage is not a constraint, payment system development should prioritize efficiency improvements.

### Payment Systems and Seigniorage — practical considerations
- Regulatory stance:
  - Regulators should encourage competition and innovation while ensuring comparable regulation across similar activities.
  - Interoperability and positive externalities should be promoted; state intervention only when necessary.
- Financial stability considerations:
  - FD-related financial instability responses may include central bank FX reserve buildup and associated regulation.
  - Expanded use of stablecoins or retail CBDC denominated in an international currency could have similar impacts to stablecoins backed by international assets, though current likelihood of Fed or ECB issuing a retail international CBDC in the near future is noted as unclear.

*IMF Working Paper excerpt: Digital Money and Central Banks Balance Sheets (selected sections).*

### Section V for six illustrative cases of how digital money will impact central banks balance sheet

### Section V for six illustrative cases of how digital money will impact central banks balance sheet line items

### IV. Base Money Issues: M0 or Not
- Any CBDC would coexist with other forms of money (so not an exclusively M0 world). The question is what the liability structure even if being distributed by banks (or nonbanks).
- Possible states:
  - Traditional or bank tokenized deposits (M1) and some balances as CBDC (M0).
  - Bank holds all the M0 (like they do with reserves today) and uses that to offer tokenized deposits (M1).
- Value added of a CBDC may lie in the ability to establish a token platform that enables new technologies to do things that cannot be easily done in traditional systems.
- Distribution model and account of M1 and M0 could look the same (or different) but the platforms may offer alternatives.
- Figure references:
  - Figure 1 shows a standard balance sheet with M0 depicted in a green shade (typically, CiC and required reserves; lately some advanced economies due to QE have excess reserves also). Bindseil (2016) cited on lean Fed pre-crisis: “the total balance sheet length was only around 1.1 times the total amount of bank notes in circulation.”
  - Figure 2 shows central bank issued CBDC or a bank/non-bank issued stablecoins counted as part of M0—think of access to central bank master account or payment rails. Left panel: CBDC is part of the central bank liability (e.g., “10” is part of the central bank liability). Right panel: bank/non-bank issued stablecoins are outside M0; stablecoins worth “10” will be in the liabilities side of banks/nonbanks, issued by debiting their excess reserves at central bank.
- If basic features of CiC hold (non-interest bearing, no caps, and complete privacy), then CBDC is digital CiC.
- RBI quote (July 2021, Deputy Governor T. Rabi Sankar):
  - “To sum up, CBDC is the same as currency issued by a central bank but takes a different form than paper (or polymer). It is sovereign currency in an electronic form and it would appear as liability (currency in circulation) on a central bank’s balance sheet. The underlying technology, form and use of a CBDC can be moulded for specific requirements. CBDCs should be exchangeable at par with cash.”
- If CBDC deviates from CiC (e.g., interest bearing and/or capped), then it is a different instrument (a policy tool) targeting a new objective.
  - Illustration: if Eurozone’s caps CBDC for retail at €1 trillion, with the underlying assumption that caps will not be binding as average retail transactions are around €1 trillion.
- Digital money velocity (instantaneous payment) will be faster than CiC. Thus, a mix of CiC and CBDC in time t+1 may be less than CiC in time t=0; base money may decline; and then so will seigniorage.
- Costs from cyber-risk:
  - If quasi-CBDC/stablecoins issuance is outside the central bank, ex-ante large costs “C” (i.e., systemically important) from cyber-risk will be picked up by the regulator due to financial stability and too-big-to-fail logic—likely absorbed by the central bank (or ministry of finance/fiscal authority), irrespective of issuer.
  - If costs are small “c” (e.g., retail CBDC issuance) then private vendors (PSPs), banks/nonbanks/Fintechs may pick up cost c.
  - Cyber risk and associated costs much higher than counterfeit paper currency that (in the literature) is not more than 0.01 percent of currency issued.
  - In the US, Fed is required by law to do full cost recovery for all payments services. In Euroland, the ECB does full cost recovery minus a "public good" adjustment.

### V. Monetary Aggregates and Bank Credit Under Digital Money — overview
- Starting framework: central bank with a policy rate as operational target.
- Six cases to study (types of money substitution):
  - (i) Bank deposits by stablecoins or e-money (assets outside the banking system) backed by banking deposits.
  - (ii) Bank deposits by stablecoins or e-money (assets outside the banking system) backed by treasury bonds or similar assets (i.e., good collateral).
  - (iii) Bank deposits by dollar-denominated stablecoins in a partially dollarized economy.
  - (iv) CiC by e-money.
  - (v) CiC by CBDC.
  - (vi) Bank deposits by CBDC (similar to reserves at central bank).

### Case (i): Substitution of Bank Deposits by Stablecoins or E-money backed by Banking Deposits
- Initial conditions (period t=0):
  - Reserve requirement (RR) of 5 percent on deposits with zero excess reserves.
  - To diversify credit and liquidity risks commercial banks hold 10 percent of deposits at current interest rates at time t=0.
  - Preference for CiC (CiC/Money) is 25 percent.
  - M1 = 4000, M0 = 1150, deposits = 3000.
- Central bank’s balance sheet at time t=0 — Commercial Bank (t=0):
  - Assets: 2550 Commercial Loans; 300 Treasury Bonds; 150 Reserves at Central Bank
  - Liabilities: 3000 Individuals’ Demand Deposits
- Central Bank (t=0):
  - Assets: 1150 Interest Bearing Financial Assets
  - Liabilities: 1000 CiC; 150 Reserves
- Period t=1: a mobile operator phone company provides e-money and, by regulation (or its own decision), the float is deposited at a commercial bank. E-money improves payments through banks, so no substitution with CiC at the central bank; only redistribution of banking deposits.
- Deposit break-up at t=1: 2800 individual demand deposits and 200 mobile phone company deposits (from original 3000).
- Mobile Operator Phone Company (t=1):
  - Assets: 100 Infrastructures; 200 Deposits with Commercial Banks
  - Liabilities: 100 Capital; 200 Customer Accounts
- Commercial Bank (t=1):
  - Assets: 2550 Commercial Loans; 300 Treasury Bonds; 150 Reserves at Central Bank
  - Liabilities: 2800 Individuals’ Demand Deposits; 200 Phone Company Demand Deposits
- Outcome: redistribution of demand deposits only; no change in asset side; central bank balance sheet does not change at all.

### Case (ii): Substitution of Bank Deposits by Stablecoins or E-money Backed by Treasury Bonds (good collateral)
- Starting point: period t=0 as in Case (i).
- Fintech Issuer of a Stablecoin (t=1a):
  - Assets: 100 Infrastructures; 200 Treasury Bond
  - Liabilities: 100 Capital; 200 Stablecoins
- Financial disintermediation dynamics:
  - Fintech increases demand for treasury bonds; commercial banks face withdrawal of 200.
  - Demand for bank reserves falls by 10 (i.e., 5 percent of 200).
  - Commercial banks likely sell bonds to Fintech, affecting Treasury bond yields; they avoid fire sales of commercial loans.
  - Central bank would probably sell treasury bonds to accommodate lower banking reserves, leading to moderate reduction of seigniorage.
- Commercial Bank (t=1a):
  - Assets: 2550 Commercial Loans; 110 Treasury Bonds; 140 Reserves at Central Bank
  - Liabilities: 2800 Individuals’ Demand Deposits
- Central Bank (t=1a):
  - Assets: 1140 Interest Bearing Financial Assets
  - Liabilities: 1000 CiC; 140 reserves
- Outcome: base money declines from 1150 to 1140 and traditional money (M1) declines from 4000 to [text truncated in source].  

*Source: wpiea2022206-print-pdf - Section V for six illustrative cases of how digital money will impact central banks balance sheet*

### 3800. If stablecoins are included in the definition of broad money, there is no change, and the

### wpiea2022206-print-pdf - 3800. If stablecoins are included in the definition of broad money, there is no change, and the

### Stablecoins, money definition, and velocity
- If stablecoins are included in the definition of broad money, there is no change, and the figure is 4000.
- Given the nature of the stablecoins, it is likely to have relative more use as a means of payment and less as store of value compared with the average banking demand deposits (in particular time deposits) and therefore the implicit velocity from the quantitative money equation will be larger. 14
- Efficient liquidity management for Fintech issuers will depend on the depth and liquidity of the treasury bond market (including repo market).
- In the example, stablecoins are outside the regulatory (and counterparty) perimeter of the central bank; under the current framework, central banks run OMO with depository institutions (mainly banks). An open question: if authorized stablecoins and PSP should have access to open current accounts at the central bank. 15

### Example dynamics: commercial bank balance sheets and credit impact
- At period t=2a (after loans start to be repaid), assumed commercial bank balance sheet:
  - Assets: 2380 Commercial Loans; 280 Treasury Bonds; 140 Reserves at Central Bank
  - Liabilities: 2800 Individuals’ Demand Deposits
- Banking credit to the private sector falls 4.8 percent.
- Large companies may substitute reduced commercial loans by issuing corporate debt or external bank lending; SMEs often cannot.
- As banking credit shrinks, the transmission mechanism of monetary policy weakens (credit will be lower).

### Case (iii) — Substitution of bank deposits by stablecoins in foreign currency (partially dollarized economy)
- Contextual assumptions:
  - Allowed to open dollar deposits in period t=0.
  - Regulation establishes a reserve requirement or liquidity ratio of 25 percent for those deposits. 16
- Balance sheets at t=0 (selected lines):
  - Commercial Bank (t=0) Assets: 2380 Commercial Loans in Domestic Currency; 280 Treasury Bonds in Domestic Currency; 140 Reserves at Central Bank; 150 Commercial Loans in Foreign Currency; 50 U.S. Treasury Bond
  - Liabilities: 2800 Individuals’ Demand Deposits in Local Currency; 200 Individuals’ Demand Deposits in Foreign Currency
  - Central Bank (t=0) Assets: 1140 Interest Bearing Financial Assets; 140 Reserves. Liabilities: 1000 CiC.
- Fintech issuer when dollar deposits are allowed (t=1):
  - Assets: 100 Infrastructures; 100 U.S. Treasury Bond
  - Liabilities: 100 Capital; 100 Stablecoins in Dollar
- Commercial Bank (t=1) (selected lines):
  - Liabilities: 100 Individuals’ Demand Deposits in Foreign Currency; 75 External Borrowing or, CB liquidity to support foreign currency liquidity (e.g., FX swap line)
  - Assets: 25 U.S. Treasury Bond; 150 Commercial Loans in Foreign Currency; 140 Reserves at Central Bank
- Central Bank (t=1) Assets include 1140 Interest Bearing Financial Assets and CB Liquidity Support in Foreign Currency to Commercial Banks; Liabilities: 1000 CiC; 140 Reserves.
- Capital outflows create dollar liquidity shortages; banks borrow internationally or receive CB foreign-currency liquidity support.
- Period t=2: banks reshuffle portfolios, reducing need for external borrowing or CB support; example balances:
  - Commercial Bank (t=2) Assets: 75 Commercial Loans in Foreign Currency; 25 U.S. Treasury Bond; Liabilities: 100 Individuals’ Demand Deposits in Foreign Currency; Reserves 140
  - Central Bank (t=2) Assets: 1140 Interest Bearing Financial Assets; Liabilities: 1000 CiC; 140 Reserves
- The example shows the impact on banking credit for partial dollarization is lower because local deposits in foreign currency allow banking lending in the same currency. 17

### Case (iv) — Substitution of CiC by e‑money
- Observed trend: declining CiC before the pandemic; digital payment tools likely to continue driving decline as world returns to a “new” normal (Kahn et al., 2022).
- Example at t=1b:
  - Commercial Bank (t=1b) Assets: 2720 Commercial Loans; 320 Treasury Bonds; 160 Reserves at Central Bank. Liabilities: 3000 Individuals’ Demand Deposits; 200 Phone Company Demand Deposits.
  - Central Bank (t=1b) Assets: 960 Interest Bearing Financial Assets; Liabilities: 800 CiC; 160 Reserves.
- Effects:
  - Substitution of CiC by e-money reduces preference for currency, increasing banking multiplier and lowering money base (1150 to 960) while keeping total Money constant at 4000.
  - CiC as a fraction of M1 is 20 percent now.
  - Supply of credit to private sector increases and seigniorage falls.

### Case (v) — Substitution of CiC by CBDC
- When CBDC replaces CiC, only composition of base money changes in period t=1c; no impact on transmission mechanism of monetary policy; improved payment-system efficiency; no change in seigniorage.
- Digital money velocity is higher (Kahn et al., 2022). CiC (t1)+ CBDC (t1) may/may not be less than CiC(t0), so seigniorage from base money may decline.
- Monetary liquidity management implication: central banks should include daily movements of CBDC demand as a new autonomous factor to estimate OMO magnitudes.
- Central Bank (t=1c) Assets/Liabilities:
  - Assets: 1150 Interest Bearing Financial Assets
  - Liabilities: 800 CiC; 200 CBDC; 150 Reserves

### Case (vi) — Substitution of bank deposits by CBDC (financial disintermediation risk)
- If CBDC replaces demand deposits and its services exceed private banking services, central bank balance sheet increases (in example from 1150 to 1340) and financial disintermediation can occur. This scenario has a low probability per central bank survey (BIS, 2022).
- Period t=1d (commercial banks cannot immediately reduce stock of credit):
  - Commercial Bank (t=1d) Assets: 2550 Commercial Loans; 110 Treasury Bonds; 140 Reserves at Central Bank. Liabilities: 2800 Individuals’ Demand Deposits.
  - Central Bank (t=1d) Assets: 1340 Interest Bearing Financial Assets. Liabilities: 1000 CiC; 200 CBDC; 140 Reserves.
- Banks sell treasury bonds to meet liquidity; central bank may purchase treasury bonds to accommodate higher base money demand.
- Extreme case: if stock of treasury bonds is insufficient, liquidity shortage may raise interbank rates well above policy rate unless central bank extends collateral for operations.
- Period t=2d: commercial banks reduce commercial loans from 2550 to 2380 to match deposits, weakening the interest rate and credit channels of monetary policy.
  - Commercial Bank (t=2d) Assets: 2380 Commercial Loans; 280 Treasury Bonds; 140 Reserves at Central Bank. Liabilities: 2800 Individuals’ Demand Deposits.

### Conclusions and policy implications
- Digital money will affect banking intermediation, external capital flows, and central bank balance sheets.
- Under fiscal dominance with reduced seigniorage, central banks may take actions to mitigate fiscal pressures; under monetary dominance, payment-system development should focus on efficiency without jeopardizing monetary policy transmission.
- Depending on substitution type between traditional money and digital money:
  - There could be banking disintermediation as deposits move away from commercial banks.
  - Stablecoins in foreign currency may increase international financial integration; developing economies face new challenges regarding capital flows.
  - Operational aspects of digital money and CBDC impacts on disintermediation are nascent; using an interest rate on CBDC may be preferable only in extraordinary cases.
- Monetary policy perspective: interest rate and credit channels may weaken when:
  - Fintech issues stablecoins backed by treasury bonds,
  - Bank deposits are substituted by CBDC,
  - Bank deposits are substituted by stablecoins in foreign currency (possible in developing economies).
- Conversely, when CiC is substituted by private digital money that is deposited in commercial banks, banking credit may expand.

*Digital Money and Central Banks Balance Sheets — Working Paper No. WP/2022/206*

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_Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022206-print-pdf.pdf_