5 May 2020
The covid-19 crisis has revealed significant deficiencies in the effective distribution of central bank liquidity both domestically and internationally. Central banks are looking towards central bank digital currencies (CBDC) to improve functionality and utility of central bank money. CBDC is about recalibrating the attractiveness of monies and will likely redefine scope and reach of central banks in financial transactions.
Covid-19 has accelerated CBDC developments. The People's Bank of China has launched its CBDC in select locations. The Riksbank has commenced implementation of its CBDC test environment. The Banque de France has issued a public tender for a number of CBDC experiments. The Bank of England has invited comments for a study to explore CBDC. The Digital Dollar Project has facilitated a public dialogue about the advantages of a CBDC for the United States. Central banks differ in their preparedness and engagement around CBDC but many are moving in the same direction.
The crisis has served as a reminder that central banks struggle to provide an effective distribution of central bank money. They cannot act as banker for the government to distribute emergency assistance to households and corporations. Touchless payment has become increasingly popular but is not offered by central banks. Money market liquidity has suffered repeatedly requiring significant central bank interventions. Sharp exchange rate movements illustrate that international liquidity is impaired.
Central bank money is the most important money in any currency area. It affords riskless settlement and is the preferred medium for large value payment transactions. Central banks issue physical bank notes for the general public and electronic reserves to domestic banks. CBDC would be a new format of central bank money exhibiting properties akin to a bearer instrument or digital token. It allows CBDC to be sent like a text message, used in peer-to-peer transactions, made programmable and available irrespective of space and time. It would be issued by the central bank to commercial banks against reserves and distributed by commercial banks to end-users against bank deposits.
CBDC would be held in electronic wallets controlled by end-users. The wallets would offer essential functionalities and be integrated with existing banking services to enable a seamless integration with the financial system. Payments at points of sale could be conducted through conventional terminals. Commercial banks could extend such wallets to their customers through existing outlets and to their large value domestic and international clients and maintain essential functions such as know-you-customer and anti-money-laundering provisions.
CBDC would offer the basis for broader access and dissemination of central bank money while enabling new controls. The tokens allow simple interactions without the need to making complex connections of payment systems. Programmability can provide additional prudential and other safeguards. CBDC would also afford unprecedented insight into payment patterns enhancing the capacity to formulate monetary policy. Privacy will need to be reviewed as CBDC can grant certain though not complete anonymity.
In retail payments, CBDC provides an autonomous infrastructure to distribute central bank money as emergency assistance in time of acute distress even when the banking system is down. CBDC would give end-users choice to conduct on-line and touchless payments in central bank money. It allows to advance financial inclusion by offering safe payment means for the unbanked population. An interest-bearing CBDC could widen the transmission channel of monetary policy and increase its effectiveness.
In wholesale payments, CBDC can enable non-banks access to central bank money, while being intermediated through banks, to offer greater confidence and security in payments. CBDC may represent a simpler approach to instant payments. It would serve as settlement medium on token-based trading platforms and be a catalyst for innovation by supporting tokenisation of financial instruments and facilitate instant delivery versus payments in a simple swap of tokens eliminating all clearing and settlement risks.
In international payments, CBDC can serve to offer central bank liquidity to international banks to meet foreign exchange needs in peer-to-peer transactions between domestic and international banks. It would establish equivalence for holding claims on governments between government securities, which international entities can hold today, and central bank money, an indirect claim on the government, which they cannot. It would enable instant foreign exchange directly in central bank money upending existing provisions in payment versus payments transactions. CBDC of smaller currencies would likely find it easier to be used in international transactions advancing local currency payments integration.
CBDC is about establishing more direct monetary relations and diversification of the payments infrastructure. Given the special role and advantages of using central bank money in domestic and international transactions its distribution today is too narrow. CBDC would make central bank money play a broader role increasing reach of liquidity and scope for reducing risks in payments. The financial sector will need to adjust and may see some of its traditional roles change. CBDC is to transform geography and utility of central banks themselves.