Central bank digital currency could harm South Korea’s financial system​

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A report published by the Bank of Korea (BoK) says that introducing a central bank digital currency (CBDC) could negatively impact South Korea’s financial system. The report, which was released on Thursday, stated that a CBDC could lead to a liquidity shortage and drive interest rates up.

Central banks from several countries have recently held discussions on the idea of introducing CBDC. However, the BoK report pointed out that introducing a CBDC would lead to a decline in commercial banks’ demand deposits, causing a cash shortfall. The bank would then need to make up for that shortfall by raising interest rates. One of the report’s authors, Kwon Oh-ik, explained: “Demand deposits are one of the biggest sources of loans by banks. When people pull out their money, banks raise rates, or lower the reserve ratio, to secure more funds.”

The report warns that this scenario would have negative effects on financial stability and could cause bank panic as the banks would be short of cash reserves that are set aside to pay depositors. Kwon pointed out the need to be more prudent and consider all of the side effects that come with issuing CBDC. This statement reiterated a warning issued by the Bank of International Settlements (BIS), which is widely regarded as the central bank of central banks. Last spring, BIS cautioned central banks to carefully consider the ramifications of introducing CBDC in relation to monetary policy and economic stability.

The managing director and chairwoman of the International Monetary Fund, Christine Legarde, is still encouraging the exploration of CBDCs as a waning demand for cash coincides with a rising demand for digital currency. A report prepared by IBM and released last November found that the majority of central banks think that they should introduce a wholesale CBDC but there is uncertainty surrounding the ability of blockchain to provide enough cost and efficiency benefits.

Many governments around the world are assessing the possibility of introducing CBDC. However, after a six-month consultation, South Korea recently announced that the country will not be introducing CBDC any time soon. An official with the BoK said that the BoK would conduct further comprehensive studies into the impact of issuing CBDC.

Sweden and Uruguay are two of five countries that are currently running CBDC pilot projects while an estimated 70% of the world’s central banks are conducting studies into the matter.

To learn more about central bank digital currencies and some of the design decisions that need to be considered when creating and launching it, read nChain’s CBDC playbook.