Impact of Central Bank Digital Currencies on Commercial Bank Profitability and Risk Management

Project Abstract

The advent of Central Bank Digital Currencies (CBDCs) promises to redefine the landscape of monetary systems and financial intermediation by altering the channels through which money circulates, how payment systems operate, and the balance between liquidity provision and risk mitigation within commercial banks. This study investigates the impact of CBDCs on commercial bank profitability and risk management, integrating theoretical modelling with empirical analysis to deliver nuanced insights for policymakers, banking institutions, and financial market participants. The?? adopts a multi-method approach, combining a dynamic stochastic general equilibrium (DSGE) framework with bank-level data and scenario simulations to assess how CBDC issuance, design features (account-based vs token-based, wholesale vs retail), and transaction routing mechanisms influence banks’ net interest margins, non-interest income, credit risk, liquidity risk, and capital adequacy. We further examine how CBDCs affect payment system efficiency, settlement risk, and the cost structure of banks, including reserve management, liquidity coverage, and funding costs in both domestic and cross-border contexts. The analysis accounts for heterogeneity across bank sizes, business models, and regulatory environments, as well as potential competitive dynamics with non-bank payment providers and fintechs. Key objectives include (i) evaluating the direct and indirect channels through which CBDCs alter banks’ profitability, such as changes in deposit franchises, payment fees, and risk-adjusted returns on lending; (ii) assessing how CBDC-related liquidity needs influence banks’ balance sheets, including reserve holdings, interbank borrowing, and liquidity buffers; (iii) exploring the implications for credit risk management, given CBDCs’ potential to modify bank funding profiles and borrowers’ repayment incentives; (iv) identifying design choices that optimize financial stability while preserving incentives for innovation and financial inclusion; and (v) proposing policy and supervisory recommendations to mitigate systemic risk and support a smooth transition. The empirical component leverages cross-country panel data, stressed scenario analyses, and robustness checks to isolate CBDC effects from pre-existing trends and regulatory shifts. We simulate various CBDC uptake rates, retail and wholesale access models, and interoperability with existing payment rails to quantify outcomes for profitability metrics (net interest margin, return on assets, cost-to-income ratio) and risk metrics (unexpected loss, value-at-risk, liquidity coverage ratio). The study also evaluates potential spillovers to capital markets, deposit competition, and cross-border payment efficiency, considering possible power dynamics among central banks, commercial banks, and fintech ecosystems. Expected findings suggest that CBDCs can improve payment efficiency and reduce settlement risk, while their impact on profitability is contingent on design choices and regulatory framing; deposit dynamics, reserve requirements, and funding costs emerge as pivotal channels shaping profitability and risk management. The research contributes to a balanced understanding of CBDC-enabled transformations, offering actionable guidance for central banks and banking institutions navigating the evolving digital currency era.

Project Overview

What This Project Is About

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A plain-language overview of how central bank digital currencies (CBDCs) might affect how banks earn money and manage risk. The project looks at how digital money issued by a central bank could change customer behavior, payment flows, and competition between banks, and what that means for profitability and risk controls in commercial banks.

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The Problem It Addresses

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Banks rely on payment services, deposits, lending, and fees for income, and they manage risks from credit, liquidity, and market changes. CBDCs could alter who holds deposits, how transactions are processed, and the cost structure of banks. The gap is understanding potential profitability and risk implications in a CBDC-enabled payments landscape and identifying strategies banks can use to adapt.

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Objectives of the Project

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1. Explain CBDCs in simple terms and outline potential impacts on bank income streams.
2. Assess how CBDCs could affect deposit funding, lending, and payments profitability.
3. Analyze risks related to liquidity, credit, and operational resilience under CBDC adoption.
4. Identify strategies banks might use to maintain profitability and manage risk.
5. Provide scenarios to illustrate possible future states and policy implications.

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What You Will Do Step by Step

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1. Review basic concepts of CBDCs and current bank revenue models.
2. Collect and summarize data from reports, case studies, and regulatory guidance.
3. Develop simple models to compare profitability under different CBDC scenarios.
4. Evaluate risk implications using qualitative indicators and basic metrics.
5. Discuss policy and strategic implications for banks and regulators.

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Expected Outcome

A clear, practical understanding of how CBDCs could affect bank profitability and risk, plus a set of actionable recommendations for banks to adapt and for regulators to consider in policy design.