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"If not its beating heart, China Evergrande Group, with its countless development subsidiaries, is at least the distended central vein of the Chinese financial system. A voluminous channel through which flows so much of the capital with which the central government force-feeds the economy, the heavily indebted group is now seeing its shares slide and its assets frozen by regulators. The question: Will it finally fail?"

"This paper presents a multi-period agent-based model for the study of macro-financial effects related to the introduction of a retail Central Bank Digital Currency (CBDC). Calibrating it with aggregate statistics of the German retail payment market, we exemplify how the model can be used to quantify the impact of a CBDC on i) the usage of alternative means of payments, ii) the composition of consumer's wealth, and iii) the banking sector disintermediation. "

"Central banks around the world are exploring the possibility of issuing retail central bank digital currencies. This column takes stock of advances in research on their possible implications for financial stability and monetary policy depending on their design. It also identifies avenues for further research that could usefully inform future policy decisions on such currencies."

The U.S. Federal Reserve (Fed) published a paper that discusses the potential benefits and financial stability implications of tokenization, the process of constructing digital representations for non-crypto assets. Among the benefits of tokenization, lowering barriers to entry into otherwise inaccessible markets and improving the liquidity of such market are the most prominent. However, it concludes that tokenizations creates interconnections between the digital asset ecosystem and the traditional financial system. At sufficient scale, tokenized assets could transmit volatility from crypto asset markets to the markets for the crypto token's reference assets.

The IMF published a paper that analyzes returns and volatility spillovers among a representative set of crypto and financial assets. The magnitude of spillovers increases during periods of heightened turbulence due to negative economic-financial news, crypto market events, or exogenous shocks. There is evidence of increasing spillovers over time, with a peak during the COVID-19 pandemic, implying growing interdependence. Crypto-assets predominantly transmit spillovers to financial markets, though reversals occur during periods of financial stress. The increased correlation during risk-off episodes suggests that crypto-assets could serve as important conduits for financial market shocks, generating financial stability risks.

The IMF published a paper that introduces a conceptual macrofinancial framework to understand and track systemic risks stemming from crypto-assets. It proposes a country-level Crypto-Risk Assessment Matrix (C-RAM) to summarize the main vulnerabilities, useful indicators, potential triggers and potential policy responses related to the crypto sector. It also discusses how experts and officials can weave in specific vulnerabilities stemming from crypto-asset activity into their assessment of systemic risk, and how they can provide policy advice and take action to help contain systemic risks when needed.

NY Fed staff investigated similarities and differences between stablecoins and money market funds (MMFs), comparing investor behavior during the stablecoin runs of 2022 and 2023 to investor behavior during the MMF runs of 2008 and 2020. They found that, similarly to MMF investors, stablecoin investors engage in flight to safety, with net flows from riskier to safer stablecoins during run periods. However, whereas in MMFs, run risk has historically materialized only in prime funds, with stablecoins, runs occurred in different stablecoin types across the 2022 and 2023 episodes. The analysis also shows that, similarly to intrafamily flows in MMFs, stablecoin flows tend to be within blockchains. A discrete "break-the-buck" threshold of $0.99 was identified, below which redemptions accelerate.

The BIS Innovation Hub, De Nederlandsche Bank and the Deutsche Bundesbank jointly launched Project Atlas, which creates a data platform that sheds light on the macroeconomic relevance of crypto-asset markets and decentralized finance (DeFi). A first proof of concept of Project Atlas was developed focusing on international flows of crypto-assets. The initial findings indicate that, although relatively small compared with total on-chain network traffic, identified flows between crypto exchanges are significant and substantial economically. Attributing geographical areas to exchanges (where possible) lays out the structure of cross-border flows. Thus, Project Atlas provides a starting point for structural analysis across jurisdictions.

The Bank of Canada [BoC] published a paper on the risks stablecoins could pose to the financial system. It argues that the stabilization mechanisms of stablecoins give rise to the risk of confidence runs, which can propagate to broader crypto-asset markets and the traditional financial sector. It also argues that stablecoins can contribute to financial stability risks by facilitating the buildup of leverage and liquidity mismatch in decentralized finance (DeFi). Such risks cannot be addressed by ensuring the price stability of stablecoins alone. Finally, it explores the potential implications of stablecoins for the current system of bank-intermediated credit and for monetary policy.

The European Securities and Markets Authority (ESMA) published its analysis of crypto-assets' risks and transmission channels to financial markets. It finds that crypto-asset markets are still small in size and their interlinkages to traditional markets are limited, but this situation may change as market growth can occur suddenly and risk transmission is possible through various channels. It recommends continuous monitoring of the crypto-asset market and its interconnectedness with the wider financial system to assess newly emerging threats in a timely manner.

The  European Commission (EC) published an assessment of digital euro issuance on financial stability and commercial bank balance sheets. It concludes that a digital euro would not pose any significant risks to financial stability as long as take-up does not exceed EUR 3,000, although small banks that normally rely mostly on deposits as a source of funding, could face a potential decrease in profitability. A digital euro produces only small changes in the response of the economy to macroeconomic shocks, especially with a cap on holdings.

The US Fed published a paper that explores whether the digital financial system creates new potential challenges to financial stability. It describes emerging vulnerabilities that could present risks to financial stability in the future if the digital asset ecosystem becomes more systemic, including: run risks among large stablecoins, valuation pressures in crypto-assets, fragilities of decentralized finance (DeFi) platforms, growing interconnectedness, and a general lack of regulation.

The European Securities and Markets Authority (ESMA) published two articles on decentralized finance (DeFi), one on developments and risks in the European Union (EU) market and another on a methodology for the categorization of smart contracts. The article on DeFi warns of serious risks to investor protection, because of the highly speculative nature of many arrangements and important operational and security vulnerabilities. DeFi's unique features have led to new market manipulation issues that need to be addressed.

"The aim of this study is to disentangle the effects of introducing an interest-bearing central bank digital currency (CBDC) for financial stability using a Diamond and Dybvig (1983) model in which (i) both CBDC and private bank deposits can be used in exchange and (ii) liquidity is created endogenously. Agents have direct access to a CBDC, which is a claim on the central bank. They use both sight deposits and CBDC to buy goods and commercial banks borrow reserves to cover liquidity needs. The introduction of an interest-bearing CBDC has direct implications for the sight deposit rate and the loan rate of banks. Besides, if the central bank aims to have a positive net worth and the absence of bank runs, a high demand for a CBDC is a necessary condition to achieve both objectives. If this is not the case, financial stability will be endangered." https://ddd.uab.cat/record/258890/

Introducing a CBDC risks destabilizing the banking system and worsening panics. The Federal Reserve tried to lessen that risk by "including" banks in the process by proposing an intermediated CBDC. Yet, with an intermediated CBDC, banks would have to cover regulatory and overhead costs to maintain CBDC accounts even though they would have no loan revenue from those funds since the CBDC is still a liability of the central bank. Moreover, shrinking the supply of deposits would likely lead to costlier credit. That means loans will be more expensive for everyone.

"MPs urge the government to alleviate privacy concerns that organisations or the Government could misuse personal data generated by the introduction of a retail digital pound, for example to monitor or control how users spend their money. These concerns could be mitigated through robust regulation and legislated protections related to the ability of any future government to access people's data.  "

The IMF published a paper that traces the development of fintech (excluding cryptocurrencies) and empirically assess its impact on financial stability in a panel of 198 countries over the period 2012-2020. The impact magnitude and statistical significance of fintech depend on the type of instrument (digital lending vs. digital capital raising). However, the overall effect turns out to be negative, albeit statistically insignificant, because of the overwhelming share of digital lending in the total. While digital capital raising is estimated to have a positive effect on financial stability in advanced economies, its effect is negative in developing countries.

The IMF published a paper that develops a model to determine the conditions in which the introduction of an interest-bearing CBDC would lead to lower deposits and lending in the banking sector. It finds that richer households increase their holdings of deposits as banks increase deposit interest rates in reaction to the CBDC introduction, which is offset by poorer households switching from deposits to the CBDC. Total deposits are more likely to fall when the mass of poorer households is large and when it is relatively costly to access bank accounts, which tends to be the case in emerging market and developing economy countries. However, even then the impact on lending is quantitatively small if banks have access to other forms of funding, such as wholesale or central bank financing.

The IMF published a paper that examines how the growing presence of Fintech firms affects the performance of traditional financial institutions. The findings point to a negative impact on profitability, primarily due to a reduction in interest income and a rise in operational costs. Although established financial institutions have tried to diversify their revenue streams, these efforts have proven inadequate to offset the losses associated with increased competition from Fintech firms. The study also reveals that various Fintech business models, such as peer-to-peer (P2P) lending and balance sheet lending, have varying effects on financial institutions. Cooperative banks experience more significant profit deterioration under both models, whereas (larger) commercial banks appear to benefit from partnerships with P2P platforms, as evidenced by an increase in non-interest income. Furthermore, the findings suggest that Fintech presence has a disproportionately larger adverse effect on banks in countries with more competitive, profitable, and developed financial systems. Interestingly, however, traditional financial institutions in countries with stronger regulatory frameworks appear to benefit from the expanding influence of Fintech firms.

The Centre for Economic Policy Research (CEPR) and the European Central Bank (ECB) hosted a joint conference that brought together academics and policy makers to discuss theoretical and practical aspects of central bank digital currencies (CBDCs). Relying on a combination of research presentations, keynote speeches and panel discussions, it was aimed at advancing the understanding of the potential benefits and costs of CBDCs from a macroeconomic and policy perspective. Lots of interesting downloadable papers!