Payment Flows, Bank Lending, and Central Bank Digital Currencies
What this paper finds — and why it matters
This paper examines how the degree of user anonymity built into a central bank digital currency (CBDC) affects bank lending decisions and what this implies for the optimal design of CBDC anonymity. “Anonymity” in the paper’s sense is the lender’s inability to discern whether a borrowing entrepreneur is diverting funds—a moral hazard problem that arises because CBDC transactions, if unobservable to lending banks, prevent the screening that banks currently perform using deposit (card-based) transaction records. In a signaling model where entrepreneurs choose a payment instrument to influence bank refinancing decisions, moderate CBDC anonymity is shown to produce an inefficient pooling equilibrium in which both high- and low-quality borrowers choose CBDC, preventing banks from screening. To avoid this pooling inefficiency, CBDC anonymity should be set either low—making CBDC less attractive to entrepreneurs seeking to obscure diversion—or high—discouraging bank lending through CBDC entirely—with high anonymity optimal when CBDC significantly benefits sales, and low anonymity otherwise. Competition between bank deposits and CBDC may impede the implementation of the low-anonymity optimum.
Summary of a forthcoming paper, AI-assisted and human-reviewed. See the linked original for the authoritative claims and full conditions.
Q1. How is “anonymity” defined, and why does it create a conflict between entrepreneurs and banks?
“Anonymity” is defined as the lender’s inability to discern an entrepreneur’s actions that enable fund diversion, and it creates a conflict because entrepreneurs may prefer anonymity (which allows diversion) while banks prefer observability (which enables screening for loan refinancing). The paper is motivated by the example of Square (Square Loans), which uses point-of-sale transaction data to screen firms for refinancing decisions; a switch to a more anonymous payment instrument removes this data, worsening the bank’s adverse selection problem. When a CBDC is issued, central banks face a design choice over how visible CBDC transaction data are to lending banks, and this design choice has real consequences for credit allocation.
Q2. What is the inefficient pooling equilibrium under moderate anonymity?
Under moderate CBDC anonymity, both high- and low-quality entrepreneurs choose CBDC, producing a pooling equilibrium in which the bank cannot distinguish project quality and cannot make screening-based refinancing decisions—an outcome that is inefficient. The pooling failure occurs because moderate anonymity is simultaneously attractive enough for low-quality types (enabling diversion) and for high-quality types (due to CBDC’s sales benefits), so neither type’s payment choice reveals useful information. The bank, unable to screen, must make refinancing decisions based on prior beliefs alone.
Q3. What is the optimal anonymity policy and when should each level apply?
Optimal CBDC anonymity should be either low or high but not moderate: specifically, it should be high when CBDC significantly benefits sales—because under those conditions bank lending through CBDC should be designed away—and low otherwise, to preserve the bank’s ability to screen by observing CBDC transaction records. Under low anonymity, CBDC is made unattractive to entrepreneurs seeking to obscure fund diversion, allowing the separating equilibrium to be restored. However, competition between deposits and CBDC may prevent the implementation of the low-anonymity optimum, because deposits offer entrepreneurs an already-monitored alternative.
Q4. What is the scope of the model?
The model is presented in the context of firm borrowing, with entrepreneurs of privately known project quality choosing payment instruments that signal type to the lending bank, but the paper notes the model can be relabeled for consumer finance by interpreting consumers as borrowers repaying from future income. The key friction is moral hazard through fund diversion enabled by anonymity; the results apply to any setting where a payment intermediary’s transaction records affect a lender’s refinancing decision. This working paper version presents theoretical results without empirical estimates of magnitudes.
Key concepts
CBDC anonymity : as defined in this paper, the lender’s inability to discern whether a borrowing entrepreneur is diverting funds, parameterized by the degree to which CBDC transaction records are visible to the lending bank; contrasted with deposit (debit card) payments, which offer limited anonymity because the bank can observe the full transaction record.
fund diversion : an entrepreneur’s action of redirecting loan proceeds for private benefit rather than productive use, facilitated by higher anonymity because the bank cannot detect the action when transaction records are obscured.
pooling equilibrium : an equilibrium in which both high- and low-quality entrepreneurs choose the same payment instrument, preventing the bank from inferring project type and making efficient refinancing decisions impossible.
separating equilibrium : an equilibrium in which high- and low-quality entrepreneurs choose different payment instruments, allowing the bank to condition its refinancing decision on the revealed type signal.