A Bank for International Settlements (BIS) working group of seven central banks has determined that the impacts of a central bank digital currency (CBDC) on crowding out banks as middlemen in transactions and as facilitators of lending could be manageable for the industry if given the time and flexibility to adjust.
The working group published not one but three new reports on Thursday exploring customer needs, technological design alternatives and financial stability implications of a general purpose or “retail” CBDC – meaning a digital currency issued directly by a central bank – that would coexist with private payment systems.
CBDCs are seen as a means of making financial services faster, accessible and cost efficient, according to leading global institutions like the BIS and the International Monetary Fund. As it is a digital representation of a jurisdiction’s official currency, it has certain perks: a retail CBDC can be issued directly to wallets on smartphones particularly to those without access to private banking services, and cut the costs of printing and managing cash. More than 80 countries around the world are currently considering or testing a potential CBDC.
The reports come on the heels of a study published by the BIS that demonstrated how CBDCs could reduce costs and speed up cross-border transactions. The European Central Bank (ECB) is gearing up for a 24-month investigation into a digital euro, and the U.S. Federal Reserve (Fed) has plans to release its own report on CBDCs. Meanwhile, China is powering ahead with trialing a digital yuan.
The reports are a follow up to the 2020 BIS publication on the foundational principles and feasibility of a CBDC. All reports were compiled by a working group of seven central banks (The Bank of Canada, the Bank of England, the Bank of Japan, the ECB, the Fed, Sweden’s Sveriges Riksbank, the Swiss National Bank) and the BIS.
“This group is helping central banks to answer difficult and practical questions about how to offer safe and neutral currency with interoperable systems that harness new technology and serve the public,” said Benoît Cœuré, head of the BIS Innovation Hub and co-chair of the working group that produced the reports, in a statement to the press.
Although the reports do not make specific design or technological recommendations, they outlined general expectations for how CBDCs should work that align with BIS objectives. Of the three reports, the one on financial stability implications is the most detailed, laying out potential risks to the banking sector that might arise from the introduction of a CBDC and how central banks could mitigate those risks.
The BIS report on the effects of a CBDC on financial stability outlined a number of risks bounded by three main uncertainties: the future structure of the financial system, the design of a CBDC and the scale of user adoption.
According to the report, risks to financial stability depend on the take-up, or rate of adoption, of a CBDC as well as bank funding, lending and resilience. If take-up is too fast, it could throw the existing financial and banking systems out of balance, the report says. The prevailing fear is that the use of any CBDC would require a shift of funds out of bank deposits and into digital cash. Without bank deposits, banks won’t have the funds to issue loans that help them make money: should CBDCs rapidly replace bank deposits, they could reduce banks’ ability to lend, leading to instability in the financial system.
But if it happens slowly, with enough time for banks to adjust, the report says the effects of such a shift would be manageable. The report lays out a number of design options that could help control CBDC take-up and the crowding out of banks including setting holding and transactional limits on CBDCs, and considering different ways of remuneration. Take-up of a CBDC will depend on a number of factors including how attractive it proves to be in comparison to cash. For example, a CBDC can be non-interest bearing like cash, in which case, it would seem less attractive: the report notes that demand for non-interest bearing electronic money in the U.K. and EU has been relatively low.
“However, CBDCs would be as safe as cash, with added electronic benefits and possibly attracting greater demand,” the report said.
If central banks issue a remunerated interest-earning CBDC it would prove to be a more attractive substitute for cash, low interest-bearing deposits or other cash-substitutes, risking rapid emptying of deposits, the report added.
“It could be attractive to households that are particularly risk-averse or have already spread deposits across multiple bank accounts to minimise balances above deposit protection limits. Businesses might also wish to transfer some of their uninsured balances to a CBDC,” the report said.
Moderating take-up through remuneration and functionality will slow sizable shifts to any CBDC according to the report.
But it also warns these considerations are not a statement of policy; only a framework for future work.
Unmet user needs
Although controlling the speed of CBDC rollout is a key consideration for financial stability, that does not mean CBDCs should not be adopted and used at scale.
The accompanying report on user needs and adoption says driving CBDC adoption is key to fulfilling central bank public policy goals that motivate its issuance.
“The CBDC system would require some capital investment, including the costs of the central bank to set up the core system as well as some costs borne by the private sector to interoperate and provide services on top of the core system,” the report said.
The report also says that any retail CBDC should meet “unmet user needs” without requiring “all users to buy new devices.”
According to the report, unmet user needs include the perks of holding money directly issued to them by the central bank like the certainty that a transaction is complete without risk of reversal (settlement finality), the ease with which assets are converted to cash (liquidity) and the trust users can place in their central bank (integrity).
“In addition, it would be important for CBDC to meet consumer or merchant demand that might not currently be met by existing payments products and services,” the report said, adding that meeting these needs involve encouraging private innovation in CBDC ecosystems.
The report also says that consumer needs and the strategies for driving CBDC adoption would vary depending on the jurisdictions, and reflect different economic needs, structures, and payment landscapes.
CBDC design options
The take-up of a CBDC also depends on its design, according to the working group’s reports.
But regardless of the design, developing and running a CBDC system would be a major undertaking for a central bank, the report on system design and interoperability said.
The report says that CBDCs will work effectively through a public-private partnership where financial institutions in both sectors cooperate to integrate CBDCs with existing payments systems.
“The central banks contributing to this report anticipate any CBDC ecosystem would involve the public and private sectors in a balance, in order to deliver the desired policy outcome and enable innovation that meets users’ evolving payment needs,” the reports said.
Any CBDC ecosystem would need a core ledger (a collection of financial accounts) with supporting infrastructure and rules, but central banks would be the only institutions entitled to issue and redeem a CBDC, the report said. It further explained that the central bank would have the ultimate responsibility for not only designing the CBDC system but also for the operation or oversight of the core ledger.
“Therefore, assigning the roles within a CBDC system would likely be the prerogative of a central bank,” the report said. “Theoretically, a central bank could perform all the functions in an ecosystem, either through directly operating or outsourcing certain functions.”
But central banks aren’t really accustomed to front-end customer service or the offering of day-to-day financial services like commercial banks. So if a CBDC is solely operated by a central bank, the bank has to build a customer interface from the ground up. According to the report, this approach may be useful for countries that don’t already have comprehensive private payment systems in place.
But the central banks that contributed to the report envision CBDC ecosystems based on a broad public-private collaboration, or a ‘tiered system’ where the core roles are assigned to the central bank and other more public-facing roles to private financial institutions like banks, the report said.
“Yet, in any CBDC system, the central bank would face additional operational or oversight tasks and accompanying challenges regardless of the division of responsibilities among the various actors,” the report said.
The report also briefly considers interoperability or the ability of payment systems to exchange information.
While the multiple CBDC prototype tested by the BIS innovation hub focused on the effectiveness of CBDCs in international payments, the reports released on Thursday mainly outlined considerations for domestic interoperability.
According to the report, interoperability would help ensure the coexistence of a CBDC system within a wider payment ecosystem.
“In a domestic context, the characteristics of pre-existing payment systems would likely play a significant role in a CBDC’s interoperability. For example, if common technical interfaces and data or messaging standards already existed, adopting these could reduce costs,” the report said.