Digital assets: another squeeze on banking profits
Crypto assets such as bitcoin threaten the dominance of official currencies. Many countries therefore expect to introduce them. China has already done this and has pushed McDonald’s to install renminbi payment systems at more of its restaurants. Unfortunately, central bank digital currencies will further reduce uneven profits for commercial banks.
Returns on equity, which for European banks rarely exceed cost, could be hit by nearly a percentage point, according to a study by central bank experts including the European Central Bank, the Federal Reserve and the Bank from England. This would be a big blow to profitability, given that they calculate that the average RoE in the developed world was 8.9% in 2000-2016.
The reason? To counter the popularity of cryptos, central bank digital currencies are also expected to be popular. Central banks are considering offering deposit accounts on terms good enough to attract ordinary citizens. You can imagine the big sucking sound of cash flowing out of the deposit accounts of big banks such as Barclays, BNP Paribas and Deutsche. These lenders depend on deposits as a reliable and cheap source of funding.
The study estimates that wholesale funding could reach two-thirds of bank debt, up from around one-third today. One of the difficulties is that credit markets can dry up in a crisis. This is the main reason UK Northern Rock Bank collapsed in 2008. Another problem is that wholesale funding is more expensive than customer deposits, especially when demand soars.
The study estimates that commercial banks may need to increase lending rates by up to 70 basis points to repair the hole in net interest income. But as Liberum’s Joachim Klement points out, there may be a problem with the thinking of central bankers. When lending becomes less profitable, for example when key rates have turned negative in Germany and Switzerland, commercial banks are increasingly reluctant to lend. Their customers are just too reluctant to charge higher interest charges.
This would mean that central banks would have disrupted the commercial banks they depend on to distribute liquidity and manage credit even more drastically than expected. Uncomfortable rests the head that wears a crown and plans to keep it.
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