The Bank for International Settlements has released a report outlining the principles that should underpin central bank digital currencies, empasising it is a development commercial banks should follow closely. 

What is happening?

The Bank for International Settlements (BIS), along with seven other central banks, has published a report looking at the creation of general purpose central bank digital currencies (CBDCs). This report is not necessarily advocating CBDCs: indeed, at the press conference, it was stressed that this is a sovereign decision. However, what the report does is put together a set of principles, which the BIS believes are key to creating a ‘safe’ CBDC. 

Reg rage – acceptance

CBDCs are the digitisation of cash or fiat currencies, much like creating a digital dollar or euro. The concept is inspired by cryptocurrencies such as bitcoin. The key difference is that rather than being decentralised, CBDCs remain under the control of central banks and their respective governments, are legal tender and subject to regulation. 

The attractions of CBDCs are that they could make payments instantaneous and even free; each ‘coin’ could be tracked, making money-laundering harder; and they could make central bank monetary and even fiscal policy more effective.  

One of the countries furthest ahead in the development of CBDCs is China, and the People’s Bank of China has already conducted its first pilot schemes. China’s primary motives are perceived to be tightening control over the economy and decoupling from the US dollar’s dominance. 

However, Bank of England deputy governor Jon Cunliffe insisted during the press conference that the BIS report was not about competition. It was also noted that CBDCs are domestic initiatives, including China’s. 

Why is it happening? 

Many countries, Sweden in particular, are seeing the use of physical cash steadily disappearing. Not only that, but central banks are aware that digital financial ecosystems are developing rapidly, and want to shape those developments. 

Facebook’s attempt to launch a stablecoin, the Libra, is also likely to have spurred leading central banks into action. Central banks risk losing a degree of control over their currencies. Stablecoins are cryptocurrencies aiming to offer price stability via the backing of a reserve asset. Libra, for example, is backed by a basket of leading fiat currencies. 

What do the bankers say? 

Most bankers, overwhelmed by the fallout from the Covid-19 pandemic and packed regulatory agendas, have not made CBDCs a priority. Banks will certainly be comforted by the report’s first principle, which is that a CBDC should do no harm to monetary and financial stability. The report’s authors explain that depending on its design, a CBDC could have broad market structural effects. If individuals and organisations were to bank directly with the central bank, that could not only disintermediate banks, but also cause flash runs on commercial banks at any sign of stress. 

Banks at risk of losing deposits could be forced to rely more on wholesale funding, something regulators want to discourage, and restrict credit supply to the economy. These risks raise a number of questions about potential mitigants. Should banks hold even more capital and liquid instruments to safeguard against flash runs? Should they only offer term deposits, so money cannot be withdrawn instantaneously via a smartphone app? 

The Banker posed these questions at a press conference. Mr Cunliffe responded that much depends on a CBDC’s design and how it tackles those risks. He explained that the risk of bank runs already exists thanks to the likes of ATMs, adding that resolution tools and deposit insurance are there to mitigate against this. 

“It’s not obvious to me that the introduction of a CBDC necessarily disintermediates the banking system. One could think of ways in which a CBDC might do that and you can think of ways of trying to reduce those risks. Those are things that will have to be discussed and analysed and decided by each jurisdiction,” he said, adding that much more work needs to be done by central banks to research this issue. 

Will it provide the incentives?  

The introduction of CBDCs needs to be carefully thought through and it is likely that in the event of one being launched, it would probably be done in consultation with the industry. 

But if CBDCs are to be launched, it will certainly promote greater efficiency and innovation in the financial system. The banks best placed to deal with this are those furthest along in their digital transformation journey and those that have a flexible and entrepreneurial approach.

Justin Pugsey is the editor of The Banker's sister publication Global Risk Regulator.

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