Digital currency: What it means for financial inclusion and private banking
|Published
The world’s central banks understand that the future of money is digital. As payments shift online, the use of cash declines and the fortunes of crypto assets rise and fall, central bankers realise that their ability to command the use of money in their economies could weaken and that the financial exclusion of un- and underbanked citizens could be cemented.
To try to forestall such developments, central banks in all the world’s major economies and most of its lesser ones are exploring the creation of digital currencies, and a handful of emerging economies have launched their own.
The widespread introduction of central bank digital currencies (CBDCs), especially in the world’s major economies, is not imminent. But the groundwork being conducted in this area is detailed and in-depth, such that many central banks will be ready to launch when their governments deem the circumstances to be right. Before that time comes, central banks have choices to make about the design of their CBDC systems, particularly those earmarked for retail use.
We spoke to two experts to understand what some of the options are and how the choices made may have an impact on financial inclusion and the role of private sector banks in this new payments landscape.
The state of play
As of June 2023, 11 countries or their currency unions had launched digital currencies, 21 had embarked on pilots, 32 had them under development and another 46 were at earlier stages of researching them. Some initiatives are exclusively for retail CBDCs (including the 11 launched), some for exclusively wholesale ones, and several large economies (such as China, the US and the EU) are exploring the launch of both.
According to the Atlantic Council Geoeconomics Centre, Central Bank Digital Currency Tracker (data sourced September 1, 2023) the digital currencies launched or in pilot are summarised in the accompanying table.
With the exception of Nigeria, all 11 that have launched CBDCs thus far are small economies in the Caribbean region. Why their speed to launch?
Marion Laboure, a senior strategist at Deutsche Bank Research and co-author of a recent white paper on digital currencies, says a motivation for them is to expand financial inclusion, as most have large numbers of un- and underbanked citizens.
For Nigeria, says Ashlin Perumall, a partner in Baker McKenzie’s Johannesburg office, an additional impetus is to shore up the use of its own currency in domestic payments, thereby reducing use of the dollar, as well as to increase the visibility and traceability of money flows.
“There and in other African countries, CBDCs could solve problems that aren’t currently being solved,” Perumall said
There is less urgency in larger, wealthier economies to move toward CBDC launch. Singapore is a case in point. After completing a pilot in late 2022, its central bank, the Monetary Authority of Singapore, stated: “The use cases for a retail CBDC are unclear, given that electronic payments … are pervasive, and households and firms … are already able to transact digitally in a fast, secure and seamless manner today.”
Speaking of wealthy economies more broadly, Perumall also cited the travails of cryptocurrency markets as a reason for central banks to hold off. “Crypto threats to sovereign liquidity have receded somewhat in the past year,” he says.
The experts we interviewed nonetheless expect several major economies to launch CBDCs this decade. “It’s a question not of if but of when,” said Laboure.
A boon to inclusion
Bringing the unbanked into the financial mainstream is one of the principal advantages that a CBDC offers, particularly, as noted earlier, to less developed countries with large percentages of unbanked in their population. A key feature of many retail CBDC projects is the ability of individuals to access a digital currency account off-line as well as online.
“This is important as it effectively decouples financial inclusion from access to the internet,” said Laboure. Thus, people will be able to make CBDC transactions over basic mobile devices, using stored value cards, for example, or even text messages.
The financial inclusion benefit is not a given warned Perumall. “To lay claim to this feature, the system for a CBDC needs to be designed with inclusion in mind.”
Off-line access is one such design element, but there are more. For example, the system must be interoperable with the diverse payment mechanisms used in an economy, and it must be accepted by merchants. It also requires simplified KYC (know-your-customer) and AML (anti-money laundering) processes.
Where the private sector fits in
Implicit in the above, and an altogether new departure in the history of banking, is the existence of a direct relationship between individual citizens and their country’s central bank, in which the former hold a CBDC account with the latter. In some countries’ designs, citizens may use a mobile app to access that account directly, but it is more likely that private sector banks will play the role of intermediary in a two-tiered digital banking system.
There are nevertheless concerns that central banks could compete with retail banks for CBDC transactions, especially if the former opted to offer interest-bearing accounts. While not excluding that possibility, Perumall downplayed disintermediation concerns.
“Private sector banks not only provide the mechanism for distribution of money into an economy,” Perumall said, “but they also provide the services and the management of such services that go along with it—things that no central bank has the capacity to do.”
Concerns also exist that CBDC accounts could exacerbate a banking crisis if customers began shifting funds from their retail banks to the safer haven of the central bank. In Perumall’s view, however, the two-tiered system of most CBDC designs, along with non-interest-bearing accounts and limits on CBDC holdings, provide a safeguard of sorts against the possibility of bank runs.
Laboure similarly saw CBDC threats to financial stability due to the same factors: their two-tiered design, zero interest accounts and caps on holdings. “Moreover, looking at countries where CBDCs are live, current adoption rates are low,” Laboure added.
Preparing for the day
As the example of Singapore suggests, the possibility of an extended wait for the wide-scale introduction of retail CBDCs is real. There is, after all, ample scepticism among politicians, and even some central bankers, about the need for CBDCs. “A solution in search of a problem?” is a recurring question about CBDCs asked in recent months and years by authoritative sources who posit the view that a digital currency offers more risk than reward.
Private sector banks should not, however, assume that launches will be delayed indefinitely. Singapore’s, for one, has made clear that it could bring forward the launch of its digital currency if “innovative uses emerge or there are signs that digital currencies not denominated in (Singapore dollars) are gaining traction as a medium of exchange locally”.
Retail banks will need to make preparations. That means, for example, readying their technology systems to be able to process CBDC transactions at scale; creating electronic wallets or other end-user interfaces so their customers can begin making CBDC transactions; and developing ideas for new services associated with the management of CBDCs. It is not too early for banks to begin taking such steps.
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