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This paper develops a tractable general equilibrium model to study the monetary policy and financial stability implications of the introduction of a retail central bank digital currency (retail CBDC). I construct a model that contains a heterogenous banking sector exhibiting market power, endogenous default, incomplete markets, and credit and deposit markets. My model replicates multiple channels through which monetary policy operate: the deposits channel, the bank lending and the risk-taking channel. I show that the transmission of monetary policy is dampened and household welfare loss arises. The introduction of a a retail CBDC is shown to improve the transmission of monetary policy. Furthermore, a retail CBDC is shown to increase competition in the monopolistic banking sector, thereby leading to a crowding in of savings via bank deposits, expanding bank intermediation, and thereby increasing output. However, a tradeoff naturally arises in the form of an increase in financial instability.
