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Full analysis· 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.