CBDC in international payments
UBS and Reinventing Bretton Woods Committee conference
IMF 2021 Spring Meetings 6-8 April 2021
Prepared remarks, 8 April 2021
Dear Conference Participants,
I would like to thank the Reinventing Bretton Woods Committee and UBS very much for the opportunity to participate in this panel discussion. In my remarks, I shall focus on CBDC in international payments. In my work with Accenture, I'm currently engaged in a large CBDC project with the central bank of France with a focus on cross-border and off-shore transactions. The BIS Innovation Hub has also recently announced an extension of the project Inthanon-Lionrock by the Bank of Thailand and Hong Kong Monetary Authority under the new name Multiple CBDC Bridge. So, CBDC and international payments are very much a trending topic.
CBDC will, I believe, have its greatest impact on international payments. International payments represent among the most urgent payment problems with broad-based implications for the distribution of international liquidity, capacity to conduct international transactions and scope for international economic integration. CBDC is set to produce two key outcomes: It will endow national currencies with new functionalities and utility; it will likely support the role of national currencies in international payments. CBDC may therefore alter the relative attractiveness of currencies and help recalibrate international payments relations and strengthen the international monetary system.
To clarify, when I refer to CBDC I mean a token based CBDC issued on a blockchain or distributed ledger technology (DLT)-platform. Account-based central bank money I consider are reserves. The innovation with CBDC rests in the adoption of digital tokens as a new format of money with properties akin to bearer instruments to complement bank notes and reserves.
CBDC is not so much about payments but more about settlement. The importance of CBDC for settlement rests in the native properties of tokens. Tokens can do certain types of transactions better in particular bi-directional trades such as payment versus payment (PvP) and delivery versus payment (DvP). If financial instruments and currencies were available as tokens, exchanges would rest on a simple token swap offering instant and atomic transactions, meaning both legs of the transaction go through simultaneously or none goes through. This would imply that trading would no longer be subject to any open positions affording riskless settlement irrespective of space and time. International securities trading and foreign exchange are therefore two key use cases for CBDC.
I shall first offer some comments on the conditions for using CBDC in an international setting, second discuss different CBDC international high-level network architectures, and then conclude.
Conditions for international CBDC use
For CBDC to be deployed in international payments, a number of additional conditions will have to be met including but not limited to: i) access policy, who will be allowed to hold CBDC; ii) liquidity accommodation, who can demand CBDC; iii) jurisdictional and regulatory boundaries, whose rules apply when CBDC is used in international payments.
- Access policy: The scope for CBDC will depend in large part on changes in central banks’ access policy. International payments today cannot be settled in central bank money except with bank notes. Central banks only offer reserves to domestic financial intermediaries. This means that the safety of central bank money is not available in international payments. While banks clear their claims in national large value payment systems in central bank money, they cannot do so when settling with a non-resident bank. This asymmetry between domestic and international payments may unduly hinder financial market integration and grant unwarranted advantages to domestic payments. If CBDC were to transform international payments, non-residents would have to hold CBDC.
The ECB hinted that a future digital euro could be held by non-residents. This would fundamentally transform how international payments are being conducted. It would change the geography of central bank money. The use of central bank money in international payments would reduce risk and establish more of a level playing field between domestic and international agents and project the safety of central bank money to the international sphere.
- Liquidity accommodation: Central banks normally conduct monetary policy to support domestic monetary conditions. While national currencies are used internationally, central banks issue reserves to meet liquidity demand to domestic entities only. This is equivalent to say a car manufacturer who produces and supplies cars only if domestic dealers demand them even though the cars are being driven everywhere in the world. Though foreign exchange market interventions are performed, those are conducted through non-resident banks.
The direct accommodation of foreign liquidity demand would be novel and make central bank money truly international. Considerations could be given to supply CBDC directly to non-resident banks against eligible collateral including foreign exchange and thereby supply to and absorb liquidity from non-resident banks. It would give greater comfort to non-resident banks that their net liquidity needs will be met directly and could be a decisive factor of making national currencies attractive for international payments.
- Jurisdictional and regulatory boundaries: The jurisdictional and regulatory reach of central banks is normally the national territory. Transactions within the national territory would be subject to domestic regulations. In conventional bank transactions, money of course never moves. With tokens, money can cross borders similar to goods. This naturally gives rise to the question of whether CBDC abroad should be governed by the provisions of the host country and/or remain subject to home country regulation or both.
Extrajurisdictional reach for central bank money would not be new. The U.S., with the provisions guiding the Office of Foreign Asset Control (OFAC) of the U.S. Treasury Department seems to stipulate that a party may violate U.S. sanctions regulations by way of using the U.S. dollar in a transaction with a party on the U.S. sanction list. This would imply that conducting payments in dollars could be subject to enforcement actions. While this may be a theoretical point only, it raises the question of how to think about central bank money when it is being used off shore. This also holds in cross-border payments where the transaction would only be completed if the prevailing regulation for each leg of the transaction is simultaneously satisfied.
CBDC international high-level network architectures
The deployment of CBDC in an international setting can occur on the basis of a number of possible network architectures. Each approach brings its own challenges and the decision of a preferred approach will rest in large part on its scalability and the nature of frictions central banks would find least problematic. I shall discuss three plausible models offering only a most high-level perspective:
- Multi network: Each CBDC would constitute its own domestic network. Entities participating in the network are only domestic entities.
The CBDC network would have to be inter-operable with other CBDC and digital asset networks to enable transactions. The cross-network inter-operability would be essential to perform PvP and DvP transactions. CBDC would have to be held by non-residents too.
- Foreign network: Central banks may deploy their CBDC on a foreign network or digital trading venue. The CBDC on a foreign platform would allow PvP and DvP transactions to occur maximising the technological advantages of a single network. The regulation for using the CBDC could be the host and/or home regulation.
The foreign network would need to grant specific controls to the central banks and meet trading standards sufficient to accommodate the central banks’ prudential safeguards. CBDC deployment could be relatively straightforward and offer a highly scalable approach to make CBDC available abroad.
- Settlement corridor: Central banks could form a third network with the participations of entities from the jurisdictions of the participating central banks. CBDCs from each participating central bank would be made available to all participant entities to be able to conduct PvP transactions. All transactions would de facto be domestic and potentially subject to common regulation for all participants. Digital assets could also be issued into the corridor or otherwise the settlement corridor would have to offer inter-operability with digital asset networks.
The settlement corridor would also have to offer inter-operability with the domestic networks of each participant central bank. Additional central bank facilities may have to be provided by the corridor and central banks would have to coordinate on the provisions for participating in the corridor. Duplication and high coordination costs may make setting up settlement corridors complicated though they benefit from the advantages of using a single network for transactions.
To conclude, the use of CBDC promises to significantly improve international payments amid the native properties of digital tokens. CBDC may significantly reduce risks in international payment, increase competition between domestic and international exchanges and offer greater choice. The deployment will depend on central banks being confident that foreign use of their currencies will be consistent with their monetary policy and financial stability objectives. Different arrangements can be found to ensure CBDC can be deployed under the highest possible prudential standards.
CBDC may offer central banks an opportunity to make their monies truly international. Central banks at times have resisted use of their currencies abroad. But the ECB has hinted that a new regime about the role of central bank money in set to emerge. CBDC may make international currencies a reality for the first time since the demonetisation of gold.