Faculty & Research


Shortly after Facebook’s Libra White Paper went live last year, China's central bank announced that its own digital currency program had been approved by the State Council, China’s cabinet. In its annual work conference earlier this month, the central bank said its digital currency is “progressing smoothly” and it will continue to steadily push forward the research and development of legal digital currencies in 2020.

Xiao Xiaolin, assistant professor of applied economics at Peking University’s Guanghua School of Management, and Dong Mei, assistant professor of economics at the University of Melbourne, teamed up to offer insights into key questions such as a central bank digital currency (CBDC)’s relations with physical currency and its impact on commercial banks and corporate investment. Their article was originally released at ftchinese.com, the Chinese-language website of The Financial Times.


A digital currency released by a country’s central bank is a digitised legal currency that is, in essence, the same as the currency in circulation but only differs in form. With the high cost of printing, transporting and clearing a physical currency, mobile payments services have offered an increasingly popular alternative to the use of cash. Figures show that cash in actual circulation in China took up only four percent of M2 in 2018, down from the 6.3 percent in 2009. If cash is used less and less as time goes by, a central bank will need to release a legal digital currency in a bid to ensure effective implementation of monetary policy and a smooth monetary transmission mechanism in the long run.

A CBDC is different from a cryptocurrency such as Bitcoin or Libra in that the latter, whether based on some algorithm or under control of large corporations and partners, is, in essence, private. These private cryptocurrencies, under official crackdown in China since 2017, do not have lawful status in the country.

China central bank’s digital currency might appear in a form similar to digital wallet or digital account. However, it will still differ a lot from popular mobile payments services such as WeChat, Alipay and Apple Pay.

As a digital base money released and under direct control of a central bank, its legal tender status is fully vouched by the sovereignty — unless in extreme situations when the country’s economy collapses and its central bank goes bankrupt.

Meanwhile, bank deposits in a physical currency might not be fully tendered by a bank if it goes bankrupt, which is far more likely in a financial crisis. In such a case, one will not be able to get his or her money in full via mobile payments services either since they are all tied to users’ bank accounts, not to mention the operation risks of these mobile payments services. However, a CBDC will not have these problems.


Only a small number of countries in Africa and Latin America have attempted to release CBDC, and they ended up unsuccessful. The design of a CBDC is crucial, and its impact on commercial banks and interaction with monetary transmission mechanism are significant aspects to consider in such a design. For example, should commercial banks be able to absorb CBDC as part of their reserve?

In our research model, commercial banks gain deposits from firms with idle funds and then lend them to companies that have investment opportunities and are in need of more liquidity. This means the CBDC at the hands of those companies is the reciprocal of bank deposits, instead of a substitute. A classical case of CBDC as a substitute is an individual holding both bank deposits (or mobile payments products) and digital currency and then choosing different payment methods in accordance with different types of exchange.

With a focus on individuals holding digital currency as a substitute for bank deposits, several researches concluded that digital currency tends to crowd out bank deposits, raise banks’ funding costs, and decrease investment. (Keister and Sanches 2018). Meanwhile, our research focuses on digital currency’s impact on commercial banks and corporate investment, instead of CBDC’s impact at the retail level. We came to the conclusion that it is reasonable to design CBDC as the reciprocal of bank deposits.


The design of a CBDC is crucial as it results in very different impact on monetary transmission and macro-economy. For instance, in an economy where CBDC completely replaces cash as the only legal currency and transaction medium and commercial banks can hold CBDC as reserves, rising interests will boost their reserves and enrich companies that have successfully applied for loans. Even those relying on their own financing will see their funds growing. Thus, corporate investment will be boosted in general. However, its impact on commercial banks, due to various factors, might be positive or negative. Meanwhile, if commercial banks cannot hold CBDC as reserves, only firms replying on their own financing instead of banks will surely be benefited, and it is uncertain concerning firms replying on bank loans or commercial banks’ ultimate profits. The situation will be even more complicated if CBDC and physical currency co-exist.

Whether commercial banks are able to hold CBDC also depends on the actual design and choice concerning a country’s financial infrastructure establishments. China’s CBDC will follow a two-tiered structure that is based on the current network of commercial banks while some European countries tend to favor a completely independent circulation and clearing network. Even in a two-tiered structure, whether commercial banks can absorb the CBDC from clients’ accounts as reserves is still a technical problem that will have different outcomes concerning the economy.

Should CBDC co-exist with physical currency in the long run or replace it completely after a transition period? This is another question China’s central bank should consider carefully before launching its legal digital currency.

Our research shows that it is possible to wield CBDC interest rates as an independent monetary policy tool whose effect will be reliably transmitted to commercial banks and the entire economy. In a time when many developed economies have seen zero or negative rates, legal digital currency with its own interest rates makes it easier for a central bank to pursue negative interest rates.

That said, every country has its own financial system and monetary policy environment, and the question whether one should resort to CBDC as a new monetary tool should be answered on a case by case basis. China is currently working on a hybrid monetary policy mechanism that involves open-market operations as well as MLF (medium-term lending facilities) and SLF (standing lending facilities). CBDC’s impact on commercial banks and monetary policy transmission in such a hybrid monetary environment is the subject Xiao is currently researching with other collaborators.

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