From private banknotes to base money: lessons from Sweden for CBDCs

Abstract

The main financial stability concern surrounding the issuance of central bank digital currency (CBDC) is that it may encourage a shift of deposits away from commercial banks and, particularly during periods of stress, contribute to bank runs. A proposed policy response to such deposit outflows is so-called pass-through funding, whereby the central bank compensates banks for lost liabilities by extending credit to commercial banks. Drawing on a historical parallel, this paper shows that such a mechanism can generate unintended credit creation, thereby increasing rather than reducing financial instability. The analysis highlights the risks associated with CBDC issuance, not only through potential strains on central bank balance sheets but also through increased vulnerabilities within the banking sector.