Introduction
New technologies present opportunities for modernizing payment and credit systems, making them more efficient and secure. However, commercial banks may resist these changes due to a sense of entitlement from historical political agreements. This article explores the potential impacts of central bank digital currencies (CBDCs) on commercial banks and the importance of embracing creative destruction for societal and economic progress.
The Traditional Banking Model
Historically, banks have controlled the money-making machine by creating credit in official currency from nothing and deciding who receives it and under what conditions. This model is backed by central banks, providing liquidity during normal times and rescuing them in crises. However, this model now faces threats from private cryptocurrencies and central bank digital currencies (CBDCs).
The Rise of CBDCs
CBDCs pose the most significant challenge to traditional banking models. While banks can defend themselves against crypto industry competition by investing in cryptocurrencies (subject to regulatory restrictions), they cannot produce the single currency everyone desires during crises: state-issued money. Banks understand that if the state enters the digital currency business, it could potentially eliminate intermediaries.
Government Intervention and Banking Regulation
For centuries, governments have relied on private payment systems (from transferable letters of exchange to bank-created money) and supported them, contributing to economic growth. This convenience came at a cost: banks’ prominent role in payment and savings systems allowed them to hold the economy hostage during crises, encouraging them to expand credit offerings and assume greater risks over time.
Example: The Glass-Steagall Act
A notable example is the U.S. Glass-Steagall Act, enacted in response to the financial crisis preceding the Great Depression. Glass-Steagall separated investment banking from commercial banking. Investment banks could take on as many risks as their clients and investors would tolerate, while commercial banks faced strict regulation and oversight to protect depositors and the payment system from those risks. However, under pressure from the financial industry, Congress and the Clinton administration dismantled Glass-Steagall in 1999, laying the groundwork for the 2008 financial crisis.
CBDCs and the Future of Banking
CBDCs could create a separation between payment systems and banks’ risk-maximizing activities. Central banks could offer digital wallets for instant payments directly to citizens, while commercial banks would continue offering loans and other financial services. This might reduce their deposit bases, making them more reliant on self-funding resources.
Central Bank Hesitation
Most central banks have been cautious about CBDCs, fearing to disrupt the commercial bank business model and potentially introduce financial uncertainty or even trigger a crisis. However, these concerns are unfounded since once a digital payment system is established, central banks would no longer be obligated to bail out private banks.
Central Bank Initiatives
Some central banks have ventured further (perhaps due to less powerful domestic banking sectors and the desire to safeguard monetary sovereignty). For example, the Brazilian central bank created Pix, an instant payment system for all citizens, businesses, and government agents. The European Central Bank plans to introduce a euro digital currency by 2029.
Reactions to CBDC Initiatives
Reactions to these initiatives have been telling. Under President Trump, the U.S. initiated an investigation into Pix, arguing it constitutes unfair trade practice (creating non-tariff barriers). This stance seems ironic given the U.S.’s unilateral imposition of tariffs on goods from around the world.
European Bank Response
European banks have criticized retail euro digital currencies as threats to their business models and their own efforts to introduce an euro-based credit card. However, this argument lacks persuasiveness since banks had ample time to create an euro-based credit card (SEPA Credit Transfer being just one example). Encouraging competition with dominant U.S. payment providers does not imply alternatives should be private.
Embracing Creative Destruction
New technologies offer opportunities to renew payment and credit systems. It would be a missed chance to let these opportunities pass due to banks’ belief in an inherited business model from centuries-old political agreements. Creative destruction is a powerful force for social and economic progress, and governments along with central banks should lead the way in creating the best possible model for the 21st century—for their citizens, not the banks.
About the Author
Katharina Pistor
Katharina Pistor is a Professor of Comparative Law at Columbia Law School and the author of The Code of Capital: How the Law Creates Wealth and Inequality (Princeton University Press, 2019).
