Payment Flows, Bank Lending, and Central Bank Digital Currencies

Abstract This paper examines the optimal observability of Central Bank Digital Currency (CBDC) payment flows in the context of bank lending. Observability matters because lenders use borrowers' payment flows to enforce repayment, and the degree of visibility varies across payment instruments. When a CBDC is introduced alongside existing payment methods, we show that moderate observability in CBDC transactions may generate a pooling equilibrium that involves inefficient credit allocation. The optimal level of observability depends on how much CBDC increases entrepreneurs' revenues: When the benefit is modest, the socially optimal design is deposit‐like; when the benefit is large, it is cash‐like.