In my keynotes at various conferences, I’ve called for a more serious and nuanced consideration of remunerated retail central bank digital currency (RCBDC) a design concept that is often treated very dismissively by central banks. In this post I attempt to synthesize recent theoretical research that assesses how a remunerated RCBDC could impact economies where bank market power suppresses deposit rates and creates structural inefficiencies in the intermediation of credit. Contrary to traditional disintermediation fears, research indicates that a remunerated RCBDC can act as a competitive “outside option,” forcing banks to raise deposit rates. If calibrated to an “intermediate range,” this paradoxically expands the deposit base and increases bank lending by relaxing liquidity and reserve constraints.[1]
Applying Bank Deposit Rate Discipline
Particularly in emerging markets with concentrated banking sectors, a remunerated RCBDC can serve as a benchmark that disciplines bank deposit rate setting. Chiu et al. (2023) and Andolfatto (2021) demonstrate that banks with significant market power often keep deposit rates artificially low to maximize profits. A remunerated RCBDC places a floor on these “sticky” rates, forcing banks to increase them to remain competitive. Andolfatto (2021) highlights that the higher deposit rates can induce the unbanked to enter the formal financial system and current depositors to increase their balances.
Expanding Bank Lending (“Crowding In”)
Chiu et al. (2023) argue that if the RCBDC rate is set correctly, the increase in total deposit volume can outweigh the higher interest cost by expanding loanable funds (“crowding in”). Furthermore, Garratt et al. (2022) note that banks benefit from a “return flow” effect, because a significant portion of the funds they lend out naturally returns to them as deposits due to their market share, which lowers their effective opportunity cost of capital.
Additionally, for banks operating under traditional reserve requirements, a RCBDC that induces deposit growth provides the regulatory headroom needed to back new loans (Andolfatto, 2021). This process also improves the bank’s liquidity coverage ratio (LCR) to the extent that it replaces volatile wholesale funding with stable retail deposits. By reducing the bank’s reliance on liabilities that can exit the bank quickly, the marginal cost of credit is lowered and expanded lending volumes supported.
Garratt et al. (2022) warn that higher RCBDC interest rates that force up deposit rates may increase market concentration. In this scenario, small banks may struggle to match the RCBDC rate while lacking the digital infrastructure of larger rivals, and they may lose deposits to those rivals. However, remunerated RCBDC may provide a “convenience offset” (e.g., speed, interface, universal acceptance) that narrows the competitive gap. This may allow smaller banks to retain deposits without needing to pay higher interest, leveling the playing field.
Funding, Lending and Arbitrage Bottlenecks
The remunerated RCBDC “crowding-in” effect assumes that banks are holding back credit due to a lack of affordable funding (“funding bottleneck”). However, if the primary bottleneck is a scarcity of creditworthy borrowers (“lending bottleneck”), banks already possess sufficient liquidity to satisfy all viable loan applications at current rates. Forcing these banks to raise deposit rates to compete with a RCBDC simply compresses banks’ net interest margins, which may lead to tighter lending standards or higher lending rates and/or fees to maintain profitability, potentially resulting in credit contraction (Chiu et al., 2023).
A third distinct scenario occurs in highly dollarized or open economies where banks engage in offshore arbitrage. In this environment, banks capture local deposits at near-zero rates but, due to structural domestic constraints, choose to invest the majority of these funds in high-yield overseas assets rather than domestic loans. A remunerated CBDC serves as a competitive benchmark that disciplines this “money machine” by providing a high-yield “outside option” for savers. Because these banks are typically over-liquid relative to their domestic loan books, a shift of deposits to the RCBDC does not “crowd out” lending; instead, it redistributes risk-free rents from private bank margins back to the public through CBDC remuneration.
| Binding Constraints by Scenario | |||
| Funding Bottleneck | Lending Bottleneck | Offshore Arbitrage | |
| Primary Constraint | Banks keep deposit rates low, resulting in a smaller pool of loanable funds. | Lack of creditworthy borrowers or shortage of bank capital. | Deposits captured at low rates and invested in high-yield offshore assets. |
| CBDC Impact | Breaks the bottleneck, drawing “idle” cash into the system and expands credit. | Squeezes margins without increasing lending, as credit demand is already met. | Reclaims risk-free rents for the public without impacting the domestic credit supply. |
| Key Indicator | High net interest margins plus high physical cash usage or large unbanked population. | Low credit growth despite high bank liquidity and low interest rates on reserves (IOR). | High offshore placements; wide spreads versus foreign yields; low loan-to-deposit ratios. |
Calibrating the RCBDC Rate (“Sweet Spot”)
The macrofinancial outcome depends heavily on the calibration of the RCBDC rate. There should be no impact if the CBDC rate is below bank deposit rates. However, if the CBDC rate exceeds the interest rate on reserves (IOR), banks make a loss on deposits, potentially increasing lending rates and/or disintermediation. To hit the “crowding in” sweet spot, the CBDC rate must below the IOR, so that banks have a strict incentive to retain deposits and continue lending (Andolfatto, 2021).
Guardrails Against Runaway Disintermediation
While theoretical “crowding-in” effects may offer a compelling case for a remunerated RCBDC, the risk of an unconstrained flight from bank deposits can be mitigated with holding limits and/or tiered remuneration. Bindseil (2020) advocates for the latter option, calling for a competitive RCBDC rate on holdings up to some threshold, while holdings exceeding the threshold would earn a significantly lower rate. This obviates the need to impose limits.
Summary and Conclusion
The success of a remunerated RCBDC depends on a deep understanding of the local financial sector. In jurisdictions where funding bottlenecks persist, characterized by high bank market power and significant “idle” physical cash, a remunerated CBDC can serve as a vital structural reform. By disciplining “sticky” retail deposit rates, it draws wealth into the formal system, relaxes regulatory constraints, and expands the volume of credit available to the real economy. In cases of offshore arbitrage, it redistributes risk-free rents back to the public without impacting the domestic credit supply.
Conversely, in jurisdictions facing lending bottlenecks, aggressive remuneration risks destabilizing the financial sector. If banks are already meeting all creditworthy demand, the increased cost of funding will simply compress margins. Consequently, the optimal path is one of controlled calibration: maintaining the RCBDC rate within the “sweet spot” that does not exceed the IOR while utilizing tiered remuneration or holding limits to mitigate disintermediation risks.
References
Andolfatto, D. (2021). “Assessing the Impact of Central Bank Digital Currency on Private Banks,” The Economic Journal, 131(525), 525-540.
Bindseil, U. (2020). “Tiered CBDC and the Financial System,” European Central Bank Working Paper No 2351, January.
Chiu, J., S.M. Davoodalhosseini, J. Jiang, and Y. Zhu. (2023). “Bank Market Power and Central Bank Digital Currency: Theory and Quantitative Assessment,” Journal of Political Economy, 131(5), 1212-1248.
Garratt, R., J. Yu, and H. Zhu (2022). “The Case for Convenience: How CBDC Design Choices Impact Monetary Policy Pass-Through,” BIS Working Papers, No 1046.
[1] In highly competitive banking systems, where deposit rates closely track policy rates, the scope for a RCBDC to “crowd in” lending is significantly diminished. In such environments, a remunerated RCBDC is more likely to lead to disintermediation, as banks lack the monopoly rents necessary to compete for deposits without raising the cost of credit.
FYI I produce a monthly digest of digital fiat currency (DFC) developments exclusively for the official sector (e.g., central banks, ministries of finance and international financial institution (e.g., the BIS, IMF, OECD, World Bank)) plus academics and firms that are active in the DFC space (commercial banks, technology providers, consultants, etc.). (DFCs include central bank digital currency (CBDC), stablecoins and tokenized deposits.) It goes out via email on the first business day of every month, and if you’re interested in being on the mailing list, please email me at john@kiffmeister.com.
