- The Time Fintech
Digital disruption for bank with Central Bank Digital Currencies (CBDC)
The trend toward digital payments, which has accelerated since the pandemic, is considered by many central banks to be a long-term threat, both to the physical cash they supply today and the broader role they play in providing a country's currency. Central banks across the world have launched consultations and pilot projects into how to create a digital form of cash, i.e. a central bank digital currency or CBDC. The consequences for banks could be profound.
The Libra project has been a catalyst. The potential for the Libra digital currency and similar projects to displace official currencies has propelled many central banks to defend the role of public money. CBDCs would have a critical advantage relative to digital “stablecoins” such as Libra in that they could provide the same rapid and convenient means of payment but their direct claim on the central bank would make them free of credit risk.
CBDCs could take several forms. A “direct” CBDC model envisages individuals or companies having a direct but electronic claim on the central bank itself. But it could make the central bank responsible for managing retail payments with all the administrative background work this involves (including “know your customer” and anti money laundering procedures). An “indirect” model would relieve the central bank of the administrative burden of payments by granting an intermediary role to the private sector, much as Libra would do. A third “hybrid” model seeks to combine aspects of both direct and indirect models.
Many central banks have launched CBDC initiatives. These include China, Sweden, UK, the euro area and US. China is already in pilot phase.
Consequences for banks could be profound. Some forms of CBDC would have profound negative consequences for commercial banks since the CBDC would displace their current role in the payments system and force changes in their funding model. Even the less disruptive hybrid model would likely impose new costs on banks and reinforce existing pressures on banks' business models.
Central banks face a dilemma. The advent of stablecoins such as Libra and the rapid advance of new payment providers on a national or global scale has propelled central banks to urgently consider CBDCs as a defensive strategy. If they do not adapt, then customer behaviour may change anyway and undermine their role. However, if they adapt too fast, they may disrupt the financial system by undermining the role of the commercial bank.
CBDC and negative interest rates
The CBDC may also be attractive to central banks in the era of negative interest rates. Bank notes and coins bear no interest and (since physical “clipping” of coins is no longer meaningful) always holds the same nominal value (barring devaluations via redenomination). In times of positive interest rates, cash will never have a return greater than electronic money at a commercial bank (and usually lower), making it unattractive as a store of value and enabling effective monetary policy transmission via interest rates charged and paid by the banking system.
Source: Moody's Investor Service, FT, Public Source.