Digital Assets: Further Pressure on Bank Profits

Crypto assets like Bitcoin threaten the dominance of official currencies. Many countries therefore expect to introduce them. China has already done this, pushing McDonald's to install e-yuan payment systems in more of its restaurants there. Unfortunately, central bank digital currencies will further depress the patchy profits of commercial banks.

Returns on equity, which rarely exceed costs for European banks, could take a hit of almost 1 percentage point, according to a study by experts from central banks such as the European Central Bank, the Federal Reserve and the Bank of England. This would be a major blow to profitability as the average RoE in the developed world was 8.9 percent over the period 2000-2016.

The reason? In order to counteract the popularity of cryptos, central bank digital currencies would also have to be popular. Central banks plan to offer deposit accounts with conditions good enough to attract ordinary citizens. You can imagine the loud sucking noise as cash flows out of the deposit accounts of high street banks such as Barclays, BNP Paribas and Deutsche. These lenders rely on deposits as a cheap, reliable source of funding.

The study estimates that wholesale financing could rise to two-thirds of bank liabilities, compared with about a third today. One difficulty is that credit markets can dry up in a crisis. This was the main reason for the collapse of the British bank Northern Rock in 2008. Another catch is that wholesale funding is more expensive than customer deposits, especially when demand increases.

The study estimates that commercial banks will need to raise lending rates by up to 70 basis points to close the gap in net interest income. But as Liberum's Joachim Klement points out, there may be a kink in central bankers' thinking. When lending becomes less profitable – for example, when key interest rates in Germany and Switzerland become negative – commercial banks become increasingly reluctant to lend. Your customers are simply too resistant to higher interest rates.

That would mean that central banks would have disrupted the commercial banks they rely on to distribute cash and manage loans even more radically than expected. The head rests uneasily, wearing a crown and planning to keep it.