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Could the move towards digital currencies worsen future financial crises?

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Could the move towards digital currencies worsen future financial crises?

Middle East News

For many, the move towards digital currency is a revolution we have all been waiting for. The belief being that this revolution would allow people or institutions to transfer funds instantly, securely and without a middleman. It offers the potential to expand international commerce, support financial inclusion, and transform how we shop, save and do business in ways we probably cannot even yet fully understand. Sounds all good then, not quite, as many have reservations about the move towards digital money and last week one of the world's top central bankers gave a speech discussing one of his major concerns.  

Jens Weidmann, the head of Germany's Bundesbank and one of the most powerful figures in European finance, warned that digital currencies, like bitcoin, have the potential to make financial crises in the future even more devastating. Speaking in Frankfurt on Wednesday, Weidmann said he believes that central banks will eventually create their own digital currencies to provide reassurance to the average citizens that such currencies are safe and stable. However, by doing so there could be an increased risk of bank runs during any future financial crisis.

Weidmann commented that "Allowing the public to hold claims on the central bank might make their liquid assets safer, because a central bank cannot become insolvent. This is a feature which will become relevant especially in times of crisis - when there will be a strong incentive for money holders to switch bank deposits into the official digital currency simply at the push of a button. But what might be a boon for savers in search of safety might be a bane for banks, as this makes a bank run potentially even easier."

Weidmann's speech further highlighted concerns that by making currencies fully digital, withdrawing money from a bank would become much simpler. Customers would no longer physically have to visit a cashpoint or bank branch to withdraw cash, customers could do it online. In times of financial crisis, customers often lose faith in the stability of the bank and the safety of their money, so decide to take out their cash. This, in turn, makes the bank's problems even worse, because they lose cash liquidity, making it more difficult for them to fulfil their obligations. 

The phenomenon of the ban run is not a new one, with the latest in the UK coming in 2007 when Northern Rock saw a run after it was revealed that it had to seek emergency assistance from the Bank of England. Northern Rock collapsed shortly afterwards.

I guess we will have to wait and see how things develop, however what is clear is that no one wants to see anything contribute to a repeat of what happened in the banking sector ten years ago.