Digital assets: another squeeze on bank profits

Crypto assets such as bitcoin threaten the dominance of official currencies. Many countries, therefore, expect to introduce them. China has already done so and has been pushing McDonald’s to install e-renminbi payment systems in more of its restaurants there. Unfortunately, central bank digital currencies will further squeeze the patchy profits of commercial banks.

Returns on equity, which for European banks rarely exceed the cost, could take a hit of almost 1 percentage point, according to a study by experts from central banks including the European Central Bank, Federal Reserve and Bank of England. That would be a serious blow to profitability, given that they calculate the average RoE across the developed world was 8.9 per cent in 2000-2016.

The reason? To counter the popularity of cryptos, central bank digital currencies would need to be popular too. Central banks envisage offering deposit accounts at terms good enough to attract ordinary citizens. You can imagine the loud sucking noise of cash draining out of the deposit accounts of high-street banks such as Barclays, BNP Paribas and Deutsche. These lenders depend on deposits as a cheap, reliable funding source.

The study estimates wholesale funding could surge to two-thirds of bank liabilities compared with about one-third today. One difficulty is that lending markets can dry up in a crisis. This was the main reason UK bank Northern Rock collapsed in 2008. Another snag is that wholesale funding is more expensive than customer deposits, particularly when demand soars.

The study estimates commercial banks might need to raise lending rates up to 70 basis points to repair the hole in net interest income. But as Joachim Klement of Liberum points out, there may be a kink in the thinking of central bankers. When lending becomes less profitable — for example, when policy rates turned negative in Germany and Switzerland — commercial banks become increasingly reluctant to lend. Their customers are simply too resistant to higher interest charges.

That would mean central banks had disrupted the commercial banks they depend on to distribute cash and manage credit even more radically than expected. Uneasy rests the head that wears a crown and plans to retain it.

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