·
As part of building the
action plan for the potential issuance of a digital shekel, and similar to
other central banks, the Bank of Israel analyzed the potential impact of
issuing a central bank digital currency on the stability of the banking system
and its ability to continue fulfilling its financial intermediation function.
·
The analysis undertaken by
the Bank of Israel shows that, under common
assumptions regarding the substitution volume between the public’s deposits and
the digital shekel, the negative impact to profitability is not expected to
lead to a significant erosion in the banking system’s business results, its
stability, or its ability to provide credit and fulfill its classic functions
in a modern economy.
·
The transfer of a certain
volume of money from the public’s deposits to the digital shekel would have
various effects on the balance sheets of the banking system and of the Bank of
Israel. Assuming that the banking system will try to maintain the credit
portfolio to the public at its pre-digital shekel level, the bank’s liquidity
ratios would erode to some extent, and the transfer of large volumes of the
public’s deposits to the digital shekel would require the banking system to
take various steps to maintain them at proper levels. The decline in the volume
of the public’s deposits is expected to lead to some increase in the banking system’s
interest expenses and to erosion of the banking system’s net profit.
·
It should be emphasized
that, similar to many other central banks, the Bank of Israel has not yet
decided whether it intends to issue a digital currency.
Similar to many central banks around
the world, the Bank of Israel is building an action plan for the potential
issuance of a central bank digital currency (CBDC), or digital shekel, also
known as “SHAKED” (the Hebrew acronym for “Digital Shekel”). In May 2021, the Bank of Israel Steering
Committee on the Potential Issuance of a Digital Shekel published a paper
entitled “A
Bank of Israel Digital Shekel – Potential Benefits, Draft Model, and Issues to
Examine”. That paper outlined the
motivations identified by the Steering Committee, presented a draft model for
discussion, and detailed the main issues to be examined. One of those issues is the effect of issuing
a digital shekel on the stability of the financial system in general, and the
stability of the banking system in particular, including its ability to
continue its financial intermediation function in the economy.
As long as the public will adopt the SHAKED
as an alternative to cash, this is not expected to materially affect the
banking system. However, any potential
transition of some of the public’s deposits to the SHAKED may have a material
impact on: (1) the structure and quality of the banking system’s sources; (2)
the banking system’s financing costs; (3) the volume and price of banking
credit to the public; and more. A
departure of the public’s deposits to SHAKED would also have direct and
potential impacts on the Bank of Israel’s balance sheet. These issues are currently being examined by
the Bank of Israel, and within that, the paper that is being published today presents
one possible approach to the examination.
Similar papers have been published by leading central banks around the
world.
This paper presents general scenarios that analyze the
potential effects of issuing a digital shekel on the balance sheet of the
Israeli banking system and, accordingly, on the Bank of Israel’s balance sheet
as well. In addition, it presents a
simulation formulated with the aim of examining the nature and intensity of the
potential effects on the business results and on main indices of the banking
system. The paper does not take into
account potential changes that the banking system may make in order to adapt
its business model to account for new developments in the world of money. In addition, it should be emphasized that the
paper is not an overall analysis of all of the potential effects of issuing a
digital shekel on the banking system, the financial system, or the entire
economy. Most of the data in this paper
are annual data for 2020, the most recent that were available at the time of
the analysis. It is important to note
that that year, when the COVID-19 crisis began, was unique both from the
standpoint of the monetary measures implemented by the Bank of Israel and their
ramifications on the Bank of Israel’s balance sheet and the balance sheets of
the banking system, and in terms of the credit market and the business results
of the banking system. The results of
the scenarios and simulations are influenced by this, and this must be taken
into account when analyzing the results presented in this paper. The low interest rate environment also has an
effect on the results of the analysis.
The main findings:
Transferring a certain volume of money
from the public’s deposits to SHAKED would have various effects on the balance
sheets of the banking system and of the Bank of Israel. The banking system’s balance sheet would
contract due to the decline in the “Public’s deposits” item on the liabilities
side and in the “Deposits at the Bank of Israel” on the assets side. The analysis in this paper shows that,
assuming that the banking system tries to maintain the credit portfolio to the
public at its pre-SHAKED level, these developments erode banks' liquidity
ratios to a certain extent. The transfer of larger volumes of the public’s
deposits to SHAKED holds the potential for significantly eroding the banks’
liquidity ratios, which would require the banking system to take various steps
to maintain them at proper levels. The
paper presents an analysis of the possible steps, as well as the implications
of those steps on the banking system’s business results.
The issuance of a digital shekel would
also lead to a change in the composition of the Bank of Israel’s balance
sheet. A “digital shekel” item would be
added on the liabilities side (as essentially an addition to total cash in
circulation), while the “monetary deposits” item would shrink in parallel. If
larger volumes of deposits are transferred to SHAKED, the Bank of Israel may
take measures that would expand its balance sheet. For instance, the paper
presents a scenario in which the Bank of Israel issues loans to the banking
system.
The decline in the volume of the
public’s deposits would lead to an increase in the banking system’s interest
expenses - and thereby to erosion of its net profit - for a number of
reasons. These include measures to
maintain deposits by increasing the interest paid on them, issuing bonds on the
capital market, obtaining loans from the Bank of Israel, or any mix of these
measures. The analysis in this paper
shows that, under common assumptions regarding the substitution volume between
the public’s deposits and SHAKED, issuing a SHAKED would harm profitability
(Figure 1), but is not expected to lead to a significant erosion in the banking
system’s business results, its stability (in particular, the Tier 1 equity
ratio remains high), or its ability to provide credit and fulfill its classic
functions in a modern economy.
Central banks around the world are
discussing the qualities and characteristics that a central bank digital
currency must have. Among other things,
discussions are being held on the need for various restrictions that would be
imposed on the volume of use of a CBDC.
Setting such restrictions could shed new light on the examination
presented in this paper, as well as on the discussion of banking
disintermediation in general. The Bank
of Israel continues to examine other issues that arise as part of the research
and preparation toward a potential issuance of a digital shekel in the
future. It should be emphasized that,
similar to many other central banks, the Bank of Israel has not yet decided
whether it intends to issue a digital currency.