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We analyze the risks to financial stability following the introduction of acentral bank digital currency (CBDC). CBDC competes with commercial bankdeposits as the household's source of liquidity. We revisit the result in theexisting literature regarding the equivalence of payment systems by consideringdifferent degrees of substitutability between payment instruments andintroducing a collateral constraint that banks must respect when borrowing fromthe central bank. When CBDC and deposits are perfect substitutes, the centralbank can offer loans to banks that render the introduction of CBDC neutral tothe real economy. Hence, there is no effect on financial stability. However,when CBDC and deposits are imperfect substitutes, the central bank cannot makethe bank indifferent to the competition from CBDC. It follows that theintroduction of CBDC has real effects on the economy. Our dynamic analysisshows that an increase in CBDC demand leads to a drop in bank profits but doesnot raise significant concerns about CBDC crowding out deposits.

Unveiling the Interplay between Central Bank Digital Currency and Bank Deposits