BIS report considers implications of central bank digital currencies
The Bank for International Settlements (BIS), an international financial organisation owned by 60 member central banks, has released a report analysing the impact of potential central bank digital currencies (CBDCs). The report offers a high-level overview of the implications of CBDCs for payments, monetary policy and financial stability.
Several central banks have started exploring the idea of issuing their own digital currencies. They are motivated by Fintech developments, the emergence of new entrants into payment services and intermediation, declining use of cash in a few countries and increasing attention to private digital tokens.
The authors note that central banks already provide digital money in the form of reserves or settlement account balances held by commercial banks and certain other financial institutions at the central bank. So, a central bank liability, denominated in an existing unit of account, which serves both as a medium of exchange and a store of value would be an innovation for general purpose users but not for wholesale entities. Hence, it would be easier to define CBDC as a new form of digital central bank money that can be distinguished from reserves or settlement balances held by commercial banks at central banks.
There are various design choices for a CBDC, including: access (widely vs restricted); degree of anonymity (ranging from complete to none); operational availability (ranging from current opening hours to 24 hours a day and seven days a week); and interest-bearing characteristics (yes or no). Each combination has different implications.
Traditionally, central banks have tended to limit access to (digital) account-based forms of central bank money to banks and to certain other financial or public institutions in some instances. This is in contrast with physical central bank money (cash), which is widely accessible.
This BIS report looks at two variants, a wholesale and a general purpose one, differentiated by their accessibility, with the former being limited a pre-defined group of users and the latter being widely accessible.
Impact on payments
While, wholesale CBDCs, combined with the use of distributed ledger or blockchain technology, may enhance settlement efficiency for transactions involving securities and derivatives, currently proposed implementations do not exhibit clear superiority over existing infrastructures. More experimentation would be required before central banks can usefully and safely implement new technologies supporting a wholesale CBDC variant.
On the other hand, a general purpose CBDC, widely available to the general public, could provide a safe, robust and convenient alternative payment instrument in jurisdictions where the use of cash is declining. However, the report says that similar benefits could be achieved through fast or even instant and efficient private retail payment products that are already in place or in development.
Certain challenges in the issuance of a general purpose CBDC are also highlighted. A central issuing such a CBDC would have to ensure the fulfilment of anti-money laundering and counter terrorism financing (AML/CFT) requirements. An anonymous CBDC could be widely used globally, including for illegal transactions. A non-anonymous CBDC allowing for digital records and traces, could improve addressing AML/ CFT requirements. But then such a traceable CBDC would not necessarily be the main conduit for illicit transactions and informal economic activities.
In some CBDC designs the “know-your-customer” (KYC) function, along with its associated costs could fall to the central bank, for which they might not necessarily be well-equipped. They could also be called upon to provide information to tax and other authorities. Moreover, central banks would have to manage privacy and anonymity issues arising from the insights obtained from private transactions.
Some of the proposed technologies for issuing and managing CBDC, such as DLT, are still in early stages of testing and questions surrounding operational risk management and governance have to addressed before deployment can be envisioned.
There is also the issue of cybersecurity to be considered, as a general purpose CBDC is open to many participants and hence to many points of attack.
Impact on monetary policy
Since digital central bank money is already available to monetary counterparties, the report only looks at the implications of a widely available CBDC for implementation and transmission of monetary policy. This will be dependent on its accessibility and on whether it is attractively remunerated through interest. These factors would determine the substitution effects of CBDC on different types of financial assets.
CBDCs could strengthen pass through of policy rate changes (such as banks adjusting interest rates in line with movements in benchmark rates by central bank). However, the authors highlight that the degree to which key market rates move in conjunction with the policy rate appears to be satisfactory for most central banks. Furthermore, alternative tools are available which could meet the same objectives.
Impact on financial stability
In times of systemic financial stress, households and other agents shift their deposits towards financial institutions perceived to be safer and/or into government securities. A CBDC could enable “digital runs” towards the central bank with unprecedented speed and scale. The benefits of deposit insurance and the stability of retail funding could be weakened, as because a risk-free CBDC provides a very safe alternative. Even stronger banks could face withdrawals in the presence of CBDC.
This effect could be amplified if the CBDC is available cross-border. Exchanging a CBDC for an international currency could potentially enable faster deleveraging in capital markets, resulting in tight funding conditions and sharp movements in foreign exchange markets.
In general, the introduction of CBDC could blue distinctions between residents and non-residents and domestic and foreign transactions. This would lead to a variety of complications. For instance, it could be more difficult to apply AML/CFT requirements because of lack of formal powers over intermediaries involved in token-based CBDC distribution. Similarly, if foreign banks were able to purchase, receive or otherwise hold “domestic” CBDC, they could use the CBDC to provide the functional equivalent of “offshore” accounts and payment services denominated in the domestic currency.
Cross-border availability of CBDCs could increase substitution away from the domestic currency, which could make monetary aggregates unstable and alter the choice of monetary instruments.
The authors note further that the introduction of CBDCs by jurisdictions with international currencies could reinforce existing costs and benefits.
Hence, the authors advise that central banks that have introduced or are seeking to introduce a CBDC should take due consideration of relevant cross-border issues. In addition, they advise that central banks and other authorities should continue monitoring digital innovations, along with their potential impact on their own operations and continue to engage with each other closely.
Read the complete report here.